Active Interest Rate Rules and the Role of Stabilization Policy R&D Tax Credits

In a series of papers, Benhabib, Schmitt-Grohé and Uribe (2001a, 2001b, 2001c, 2002 and 2004) have shown that active interest rules may lead to very unexpected consequences: indeterminacy, deflation traps, large cyclical instability, and can even lead to chaotic dynamics under standard sets of parameter values. This paper explores this particular model model and puts forward four basic points: (i) the model developed by Benhabib and associates seems to suffer from serious drawbacks to be used as a theoretical benchmark to guide optimal monetary policy, as the more aggressive the central bank becomes, the more unstable the economy will be; (ii) the time span required to achieve successful control is generally small, by linear feedback techniques – the OGY method – without producing modifications to the original model, apart from locally changing its type of stability; (iii) ignorance about the true state of initial conditions are not a serious impediment to obtain control of the chaotic dynamics in the model; (iv) we argue that the conventional view of economic policy in nonlinear general equilibrium models – when endogenous fluctuations exist in optimizing models, the associated policy advice is laissez—faire – seems to be based on a misconception of chaos in general, and on the control of chaos in particular.