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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.

Suggested Citation

  • Huang, Kevin X.D. & Meng, Qinglai & Xue, Jianpo, 2009. "Is forward-looking inflation targeting destabilizing? The role of policy's response to current output under endogenous investment," Journal of Economic Dynamics and Control, Elsevier, vol. 33(2), pages 409-430, February.
  • Handle: RePEc:eee:dyncon:v:33:y:2009:i:2:p:409-430
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    11. Mr. Marco Airaudo & Mr. Edward F Buffie & Luis-Felipe Zanna, 2016. "Inflation Targeting and Exchange Rate Management In Less Developed Countries," IMF Working Papers 2016/055, International Monetary Fund.
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    Keywords

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

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory

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