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

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  • Jean-Pascal Bénassy

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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. Copyright Springer-Verlag Berlin/Heidelberg 2006

Suggested Citation

  • Jean-Pascal Bénassy, 2006. "Interest rate rules, inflation and the Taylor principle: an analytical exploration," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(1), pages 143-162, January.
  • Handle: RePEc:spr:joecth:v:27:y:2006:i:1:p:143-162
    DOI: 10.1007/s00199-004-0551-z
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    Cited by:

    1. ZHENG, Tingguo & WANG, Xia & GUO, Huiming, 2012. "Estimating forward-looking rules for China's Monetary Policy: A regime-switching perspective," China Economic Review, Elsevier, vol. 23(1), pages 47-59.
    2. Bénassy, Jean-Pascal, 2008. "Employment targeting," Economics Letters, Elsevier, vol. 99(2), pages 320-323, May.

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