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Interest rate rules, inflation and the Taylor principle: An analytical exploration

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  • Jean-Pascal Bénassy

    (CEPREMAP - Centre pour la recherche économique et ses applications - Centre pour la recherche économique et ses applications, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris)

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    Abstract

    The purpose of this article is to characterize optimal interest rate rules in the framework of a dynamic stochastic general equilibrium model, and notably to scrutinize the "Taylor principle", according to which the nominal interest rate should respond more than one for one to inflation. This model yields explicit solutions for the optimal rule. We find that the elasticity of response depends on numerous factors, such as the degree of price rigidity, the autocorrelation of the underlying shocks, or which measure of inflation is used. In general the optimal elasticity of the interest rate with respect to inflation needs not be greater than one.

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    Bibliographic Info

    Paper provided by HAL in its series PSE Working Papers with number halshs-00590564.

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    Date of creation: Dec 2005
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    Handle: RePEc:hal:psewpa:halshs-00590564

    Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00590564
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    Related research

    Keywords: Taylor principle ; interest rate rules ; Taylor rules ; inflation ; optimal monetary policy;

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    1. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(2), pages 221-235, April.
    2. Dale W. Henderson & Jinill Kim, 1998. "The choice of a monetary policy reaction function in a simple optimizing model," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 601, Board of Governors of the Federal Reserve System (U.S.).
    3. Michael B. Devereux & James Yetman, 2001. "Predetermined Prices and the Persistent Effects of Money on Output," Working Papers 01-13, Bank of Canada.
    4. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers, Federal Reserve Bank of St. Louis 2000-001, Federal Reserve Bank of St. Louis.
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