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Discretionary Policy and Multiple Equilibria in LQ RE Models

Author

Listed:
  • Andrew Blake

    (Bank of England)

  • Tatiana Kirsanova

    (Department of Economics, University of Exeter)

Abstract
We study discretionary equilibria in dynamic linear-quadratic rational expectations models. In contrast to the assumptions that pervade this literature we show that these models do have multiple equilibria in some situations. We investigate general properties of discretionary equilibria. We demonstrate that for multiple equilibria to exist, models must have some `history dependence' that implies sluggish adjustment. This creates possibility to have different but mutually consistent beliefs of economic agents about the future speed of stabilization. Multiple equilibria are likely to occur, in particular if there are complementarities in the model. We demonstrate the existence of multiple discretionary equilibria by example. In a simple New Keynesian model of optimal monetary policy, but with fiscal solvency constraint, monetary policy can be either `active' or `passive' in the sense of Leeper (1991), depending on the strength of fiscal control of debt. There is an intermediate strength of fiscal control when both active and passive policies are possible.

Suggested Citation

  • Andrew Blake & Tatiana Kirsanova, 2008. "Discretionary Policy and Multiple Equilibria in LQ RE Models," Discussion Papers 0813, University of Exeter, Department of Economics.
    • Handle: RePEc:exe:wpaper:0813
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    References listed on IDEAS

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    More about this item

    Keywords

    Time Consistency; Discretion; Multiple Equilibria;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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