The route to chaos under stabilizing passive monetary policy

Abstract Can a locally stable equilibrium undergo a global indeterminate solution? This paper investigates the conditions for the emergence of homoclinic chaos in the neighborhood area of local stability, within a generalized monetary model, as developed in Dupor (2001). Specifically, under the same parameter configuration that ensures uniqueness, and along with a passive monetary policy rule followed by the monetary authority, this analysis demonstrates that a stable limit cycle may bifurcate from a homoclinic orbit connecting the equilibrium to itself. The resulting complex dynamics reveals a new attracting set in the global structure of the model, where equilibrium trajectories implied by the eigenvalues of the system are eventually trapped, thus constraining the dynamics in an outer region away from the desired steady state. Consequently, a passive monetary policy action, that is traditionally expected to stabilize the economy, may instead generate an undesired and not predetermined macroeconomic outcome.