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Firm-specific capital, nominal rigidities, and the Taylor principle

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In the presence of firm-specific capital the Taylor principle can generate multiple equilibria. Sveen and Weinke (2005b) obtain that result in the context of a Calvo-tyle sticky price model. One potential criticism is that the price stickiness which is needed for our theoretical result to be relevant from a practical point of view is somewhat to the high part of available empirical estimates. In the present paper we show that if nominal wages are not fully flexible (which is an uncontroversial empirical fact) then the Taylor principle fails already for some minor degree of price stickiness. We use our model to explain the consequences of both nominal rigidities for the desirability of alternative interest rate rules.

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Paper provided by Norges Bank in its series Working Paper with number 2006/06.

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Length: 23 pages
Date of creation: 31 May 2006
Date of revision:
Handle: RePEc:bno:worpap:2006_06

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Keywords: Nominal Rigidities; Aggregate Investment; Monetary Policy.;

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  1. Jess Benhabib & Stefano Eusepi, 2005. "The design of monetary and fiscal policy: a global perspective," Proceedings, Federal Reserve Bank of San Francisco.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  3. Mark Bils & Peter J. Klenow, 2002. "Some Evidence on the Importance of Sticky Prices," NBER Working Papers 9069, National Bureau of Economic Research, Inc.
  4. Carlstrom, Charles T. & Fuerst, Timothy S., 2005. "Investment and interest rate policy: a discrete time analysis," Journal of Economic Theory, Elsevier, vol. 123(1), pages 4-20, July.
  5. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  6. Rochelle M. Edge & Jeremy B. Rudd, 2002. "Taxation and the Taylor principle," Finance and Economics Discussion Series 2002-51, Board of Governors of the Federal Reserve System (U.S.).
  7. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  8. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  9. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  10. Roger E.A. Farmer, 1990. "Sticky Prices," UCLA Economics Working Papers 588, UCLA Department of Economics.
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