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Does It Matter (for Equilibrium Determinacy) What Price Index the Central Bank Targets?

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Author Info

  • Charles T. Carlstrom

    () (Federal Reserve Bank of Cleveland)

  • Timothy S. Fuerst

    () (Bowling Green State University)

  • Fabio Ghironi

    () (Boston College)

Abstract

What inflation rate should the central bank target? We address determinacy issues related to this question in a two-sector model in which prices can differ in equilibrium. We assume that the degree of nominal price stickiness can vary across the sectors and that labor is immobile. The contribution of this paper is to demonstrate that a modified Taylor Principle holds in this environment. If the central bank elects to target sector one, and if it responds with a coefficient greater than unity to price movements in this sector, then this policy rule will ensure determinacy across all sectors. The results of this paper have at least two implications. First, the equilibrium-determinacy criterion does not imply a preference to any particular measure of inflation. Second, since the Taylor Principle applies at the sectoral level, there is no need for a Taylor Principle at the aggregate level.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 533.

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Length: 27 pages
Date of creation: 23 Apr 2002
Date of revision: 07 Feb 2003
Handle: RePEc:boc:bocoec:533

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Keywords: Determinacy; Sectoral Taylor Rule; Taylor Principle;

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References

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  1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  2. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  3. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  4. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
  5. Rotemberg, Julio J, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Wiley Blackwell, vol. 49(4), pages 517-31, October.
  6. Sharon Kozicki, 1999. "How useful are Taylor rules for monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-33.
  7. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
  8. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  9. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
  10. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  11. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
  12. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  14. William Kerr & Robert G. King, 1996. "Limits on interest rate rules in the IS model," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 47-75.
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Citations

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Cited by:
  1. Alexander Mihailov, 2005. "Has More Independence Affected Bank of England's Reaction Function under Inflation Targeting? Lessons from Taylor Rule Empirics," Economics Discussion Papers 601, University of Essex, Department of Economics.
  2. Luis-Felipe Zanna & Marco Airaudo, 2005. "Learning about which measure of inflation to target," Computing in Economics and Finance 2005 176, Society for Computational Economics.
  3. Mirco Soffritti & Francesco Zanetti, 2008. "The advantage of tying one's hands: revisited," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 13(2), pages 135-149.
  4. Huw Dixon & Engin Kara, 2005. "Persistence and nominal inertia in a generalized Taylor economy - how longer contracts dominate shorter contracts," Working Paper Series 489, European Central Bank.
  5. Dixon, Huw & Kara, Engin, 2011. "Contract length heterogeneity and the persistence of monetary shocks in a dynamic generalized Taylor economy," European Economic Review, Elsevier, vol. 55(2), pages 280-292, February.
  6. Stephen McKnight, 2011. "Investment and interest rate policy in the open economy," Oxford Economic Papers, Oxford University Press, vol. 63(4), pages 673-699, December.
  7. Carlos Carvalho, 2006. "Heterogeneity in Price Stickiness and the Real Effects of Monetary Shocks," The B.E. Journal of Macroeconomics, De Gruyter, vol. 0(1), pages 1.
  8. Kolver Hernandez, 2004. "Inflation and Output Dynamics with State-Dependent Frequency of Price Changes," Macroeconomics 0411020, EconWPA.
  9. Rajeev Dhawan & Karsten Jeske, 2007. "Taylor rules with headline inflation: a bad idea," Working Paper 2007-14, Federal Reserve Bank of Atlanta.
  10. Marco Airaudo & Luis-Felipe Zanna, 2012. "Equilibrium Determinacy and Inflation Measures for Interest Rate Rules," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(4), pages 573-592, October.
  11. Vahagn Galstyan & Michael Wycherley, 2009. "Optimal Policy and the Sectoral Composition of Output in a New Keynesian Model," The Institute for International Integration Studies Discussion Paper Series iiisdp394, IIIS.
  12. Ko, Jun-Hyung, 2011. "Optimal monetary policy with durable services: user cost versus purchase price," MPRA Paper 34147, University Library of Munich, Germany.

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