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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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Web page: http://www.elsevier.com/locate/jedc

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

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References

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Cited by:
  1. Stephen McKnight, 2011. "Investment and interest rate policy in the open economy," Serie documentos de trabajo del Centro de Estudios Económicos 2011-02, El Colegio de México, Centro de Estudios Económicos.
  2. Takushi Kurozumi & Willem Van Zandweghe, 2011. "Determinacy under Inflation Targeting Interest Rate Policy in a Sticky Price Model with Investment (and Labor Bargaining)," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43(5), pages 1019-1033, 08.
  3. Vadim Khramov, 2012. "Assessing DSGE Models with Capital Accumulation and Indeterminacy," IMF Working Papers 12/83, International Monetary Fund.

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