Chapter List

The paper relates to the burgeoning literature that combines an interest-rate reaction function of the central bank with an IS equation and a Phillips curve relationship. It takes up the deterministic prototype model advocated by J.B. Taylor and D. Romer and, under the assumption of open market operations, makes the implied dynamics of bonds and high-powered money explicit. As a minor extension, consumption, via disposable income, is supposed to depend on the interest payments on bonds. The resulting dynamic system is possibly totally unstable, that is, no coefficients in the Taylor rule are able to achieve local stability. A numerical investigation demonstrates that stability as well as instability can be brought about by fairly reasonable parameter values. On the other hand, full convergence and divergence are both extremely slow. This implies that, practically, there is a whole continuum of stable equilibria, such that the bond dynamics can be said to exhibit near-hysteresis.

1 Introduction

The traditional IS-LM model and its various dynamic extensions have been designed to understand macroeconomic fluctuations. Regarding monetary policy (MP), this framework is based on the supposition that the central bank targets the money supply. In recent...