Oscillatory behaviour in New Keynesian model with endogenous entry

General DSGE Modeling
1

Dear Professor

Sorry to bother you

I use a New Keynesian model with endogenous entry to evaluate the effect of a capital income tax reform. The IRFs display abnormal oscillatory behaviour if I assume a ‘current-looking’ Taylor rule, i.e., nominal interest only responds to current inflation. However, if I add a ‘foward-looking’ part in the monetary policy by assuming that the central bank also aggressively (a coefficient larger than 4) responds to expected future inflation, the oscillatory behaviour disappears. Hence, I wonder, from a technical perspective, whether this can be a feature of model, or it can only be the case that there is something wrong with the timing as you suggested under other threads. Could you please help me with this?

entry_permanent.mod (4.7 KB)

2

It’s hard to tell. But your model seems to have the usual determinacy region with inflation feedback requiring to be bigger than 1. With a wrong timing that is often not the case. That weakly suggests it’s a feature of the model. You may want to try to understand why there are oscillations.