Date of Original Version

11-2009

Type

Working Paper

Rights Management

All Rights Reserved

Abstract or Description

Cochrane (2007) has strongly questioned the basic economic logic of current monetary policy analysis, arguing that New Keynesian (NK) models imply rational expectations paths with explosive inflation that do not imply explosions in real variables relevant for transversality conditions. Consequently, the usual logic does not rule out solutions with explosive inflation. That result does not, however, justify negative conclusions about NK analysis, for a different criterion is logically satisfactory. It is that, to be plausible, a RE solution must satisfy the property of least-squares learnability. Adoption of this criterion serves to justify in principle the bulk of current mainstream analysis.

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