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Rules-based monetary policy and the threat of indeterminacy when trend inflation is low

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  • Khan, Hashmat
  • Phaneuf, Louis
  • Victor, Jean Gardy

Abstract

Indeterminacy in new Keynesian models with Calvo-contracts can occur even at low trend inflation levels of 2% or 3%. The interaction of trend inflation with nominal wage rigidity and trend growth in output causes large distortions in the steady state and expands the indeterminacy region. Consequently, even interest rate rules with strong inflation responses may not be sufficient to ensure determinacy. A policy rule reacting to output growth but not to output gap significantly increases the prospect of determinacy. Although the threat of indeterminacy is less severe under Taylor-contracts, significant departures from the original Taylor Principle are required for determinacy.

Suggested Citation

  • Khan, Hashmat & Phaneuf, Louis & Victor, Jean Gardy, 2020. "Rules-based monetary policy and the threat of indeterminacy when trend inflation is low," Journal of Monetary Economics, Elsevier, vol. 114(C), pages 317-333.
  • Handle: RePEc:eee:moneco:v:114:y:2020:i:c:p:317-333
    DOI: 10.1016/j.jmoneco.2019.03.001
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    Cited by:

    1. Haque, Qazi & Groshenny, Nicolas & Weder, Mark, 2021. "Do we really know that U.S. monetary policy was destabilizing in the 1970s?," European Economic Review, Elsevier, vol. 131(C).
    2. Louis Phaneuf & Jean Gardy Victor, 2019. "Long‐Run Inflation and the Distorting Effects of Sticky Wages and Technical Change," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 51(1), pages 5-42, February.
    3. Joshua Brault & Hashmat Khan & Louis Phaneuf & Jean Gardy Victor, 2021. "US Postwar Macroeconomic Fluctuations Without Indeterminacy," Carleton Economic Papers 21-01, Carleton University, Department of Economics, revised 25 May 2021.
    4. Hashmat Khan & Louis Phaneuf & Jean-Gardy Victor, 2020. "A Tale of Two Major Postwar Business Cycle Episodes," Carleton Economic Papers 20-03, Carleton University, Department of Economics, revised 20 Apr 2020.
    5. Kengo Nutahara, 2021. "Trend inflation, asset prices and monetary policy," CIGS Working Paper Series 21-004E, The Canon Institute for Global Studies.
    6. Yasuo Hirose & Takushi Kurozumi & Willem Van Zandweghe, 2021. "Inflation Gap Persistence, Indeterminacy, and Monetary Policy," Working Papers 202105, Federal Reserve Bank of Cleveland.

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    More about this item

    Keywords

    Low trend inflation; Taylor rule; Output gap; Output growth; Sticky wages; Trend growth; Determinacy;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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