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Inertial Taylor rules: the benefit of signaling future policy

  • Charles T. Carlstrom
  • Timothy S. Fuerst

We trace the consequences of an energy shock on the economy under two different monetary policy rules: a standard Taylor rule where the Fed responds to inflation and the output gap; and a Taylor rule with inertia where the Fed moves slowly to the rate predicted by the standard rule. We show that with both sticky wages and sticky prices, the outcome of an inertial Taylor rule is superior to that of the standard rule, in the sense that inflation is lower and output is higher following an adverse energy shock. However, if prices alone are sticky, things are less clear and the standard rule delivers substantially less inflation than the inertial rule in the short run.

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File URL: http://www.clevelandfed.org/research/PolicyDis/pdp17.pdf
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Article provided by Federal Reserve Bank of Cleveland in its journal Policy Discussion Papers.

Volume (Year): (2007)
Issue (Month): Apr ()
Pages:

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Handle: RePEc:fip:fedcpd:y:2007:i:apr:n:17
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  1. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  2. 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.).
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  4. 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.
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