Positive steady state inflation and indeterminacy


I am currently conducting a welfare analysis of optimal simple monetary policy rules. Initially, I estimated a model using data for a Small Open Economy (SOE). The model is nonlinear, and I encountered challenges with estimation, primarily related to indeterminacy issues arising from positive steady-state inflation. In addressing these indeterminacy problems, I incorporated full indexation to past inflation. However, I am aware that this assumption has been criticized in the literature.

I searched in the forum for similar issues, but the references were to the paper by Ascari and Sbordone (2014) and Professor Pfeifer’s corresponding mod file. Despite comparing my mod file with the latter, I couldn’t discern any differences or alternative mechanism, at least not in the non-linear version.

Does anyone know of an alternative method to address indeterminacy other than full indexation?

I would greatly appreciate any insights or suggestions on alternative approaches to handle indeterminacy in the context of positive steady-state inflation.

Thank you!

Yes, full indexation does not suffer from the larger indeterminacy with trend inflation. But that’s not necessarily a satisfying fix. You may want to try why your model prefers the indeterminacy region. Are there particular observables that drive this?