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Is forward-looking inflation targeting destabilizing? The role of policy's response to current output under endogenous investment

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  • Huang, Kevin X.D.
  • Meng, Qinglai
  • Xue, Jianpo

Abstract

We show that, with endogenous investment, virtually all monetary policy rules that set a nominal interest rate in response solely to expected future inflation induce real indeterminacy in models with (i) staggered prices, (ii) staggered prices and staggered wages, and (iii) staggered prices, staggered wages, and firm-specific capital. In (i), policy's response to current output can help significantly in ensuring determinacy with an infinite labor supply elasticity, but little with empirically plausible labor supply elasticity. In (ii), responding to output always helps a great deal, though under low price stickiness and without capital adjustment cost it may call for a moderate response to output in order to ensure determinacy for a wide range of response to inflation. In (iii), even a tiny response to output can always render equilibrium determinate for a wide range of response to inflation.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 33 (2009)
Issue (Month): 2 (February)
Pages: 409-430

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Handle: RePEc:eee:dyncon:v:33:y:2009:i:2:p:409-430

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Keywords: Forward-looking inflation targeting Current output Endogenous investment Nominal rigidities Firm-specific capital;

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Cited by:
  1. Stephen McKnight, 2007. "Investment and Interest Rate Policy in the Open Economy," Economics & Management Discussion Papers em-dp2007-51, Henley Business School, Reading University.
  2. Takushi Kurozumi & Willem Van Zandweghe, 2010. "Determinacy under inflation targeting interest rate policy in a sticky price model with investment (and labor bargaining)," Research Working Paper RWP 10-15, Federal Reserve Bank of Kansas City.
  3. Vadim Khramov, 2012. "Assessing Dsge Models with Capital Accumulation and Indeterminacy," IMF Working Papers 12/83, International Monetary Fund.
  4. Tommy Sveen & Lutz Weinke, 2010. "The Taylor Principle in a medium-scale macroeconomic model," Working Paper 2010/09, Norges Bank.
  5. Buffie, Edward F., 2013. "The Taylor principle fights back, Part I," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2771-2795.
  6. Kurozumi, Takushi & Van Zandweghe, Willem, 2008. "Investment, interest rate policy, and equilibrium stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1489-1516, May.

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