STABILIZATION POLICY CAN LEAD TO CHAOS

Nonlinearities in economies, as elsewhere, can generate chaotic equilibria. The presence of Pareto‐inferior chaotic equilibria might seem reason enough to use stabilization policy to select preferable equilibria. However, I show that a stabilization policy with feedback can itself lead to chaotic dynamics. Thus the existence of nonlinearities in the economy does not by itself justify monetary or fiscal policies aimed at reducing economic instability. Current evidence cannot distinguish whether monetary policy stabilizes a nonlinear economy, creates nonlinear dynamics in the economy, or both.