Monetary and Economic Studies Vol.27 / November 2009

2009 International Conference "Financial System and Monetary Policy Implementation," Keynote Speech, The Role of "Determinacy" in Monetary Policy Analysis

Bennett T. McCallum

It is well known that the concept of "determinacy"-a single stable solution-plays a major role in contemporary monetary policy analysis. But while determinacy is desirable, other things equal, it is not necessary for a solution to be plausible and is not sufficient for a solution to be desirable. There is a related but distinct criterion of "learnability" that seems more crucial. This paper argues that recognition of information feasibility requires that a candidate solution must, to be plausible, be quantitatively learnable on the basis of information generated by the economy itself. Since a prominent least- squares (LS) learning process is highly "biased" toward learnability, it is reasonable to regard it as a necessary condition for any specific solution to be relevant. This implies that determinacy is not necessary for policy analysis; there may be more than one stable solution, but only one that is LS learnable. Also, determinacy is not sufficient for satisfactory policy analysis; explosive solutions ertaining to nominal variables will not be eliminated by transversality conditions. For these and other reasons, the role of determinacy in monetary policy analysis should be reconsidered and substantially de-emphasized.

Keywords: Determinacy; Learnability; Rational expectations; Multiple solutions; Monetary policy

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

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