Citation:
 | 675_pillrevision1.pdf | 538 KB |
Abstract:
In the context of a small monetary DSGE model of the business cycle, this paper investigates the interrelationship between structural economic reform (modeled as the introduction of greater competition in the goods market) and monetary stability (captured by the dynamic stability of the resulting macroeconomic system). After making minor but plausible adjustments to the standard New Keynesian macroeconomic framework, the paper demonstrates that a conventional monetary policy framework, defined by adherence to the so–called Taylor principle, may – contrary to the received wisdom – fail to maintain macroeconomic and monetary stability. The likelihood of such failure increases as structural economic reform is introduced for two reasons: first, greater goods market competition narrows equilibrium mark–ups and thus the leverage monetary policy exerts over cyclical inflation developments; and, second, private sector expectations are subject to non–fundamental shocks that arise from the uncertainty surrounding the effectiveness of structural reform.