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The Taylor Principle in a medium-scale macroeconomic model

  • Tommy Sveen


    (Norges Bank (Central Bank of Norway))

  • Lutz Weinke


    (Humboldt-Universität zu Berlin)

The Taylor Principle is often used to explain macroeconomic stability (see, e.g., Clarida et al. 2000). The reason is that this simple principle guarantees determinacy, i.e., local uniqueness of rational expectations equilibrium, in many New Keynesian models. However, analyses of determinacy are generally conducted in the context of highly stylized models. In the present paper we use a medium-scale model which combines features that have been shown to explain fairly well postwar U.S. business cycles. Our main result demonstrates that the stability properties of forward-looking interest rate rules are very similar to the corresponding outcomes under current-looking rules. This is in stark contrast with many findings that have been obtained in the context of models whose empirical relevance is limited.

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Paper provided by Norges Bank in its series Working Paper with number 2010/09.

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Length: 25 pages
Date of creation: 28 May 2010
Date of revision:
Handle: RePEc:bno:worpap:2010_09
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  1. Andreas Hornstein & Alexander L. Wolman, 2005. "Trend inflation, firm-specific capital, and sticky prices," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 57-83.
  2. Tommy Sveen & Lutz Weinke, 2006. "Firm-specific capital, nominal rigidities, and the Taylor principle," Working Paper 2006/06, Norges Bank.
  3. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  4. Frank Smets & Rafael Wouters, 2007. "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, American Economic Association, vol. 97(3), pages 586-606, June.
  5. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices 09-191, Review of Economic Dynamics.
  6. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  7. 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.
  8. Huang, Kevin X.D. & Meng, Qinglai, 2007. "Capital and macroeconomic instability in a discrete-time model with forward-looking interest rate rules," Journal of Economic Dynamics and Control, Elsevier, vol. 31(8), pages 2802-2826, August.
  9. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
  10. David E. Altig & Lawrence J. Christiano & Martin Eichenbaum & Jesper Linde, 2010. "Firm-specific capital, nominal rigidities and the business cycle," International Finance Discussion Papers 990, Board of Governors of the Federal Reserve System (U.S.).
  11. Charles T. Carlstrom & Timothy S. Fuerst, 2003. "Investment and interest rate policy: a discrete time analysis," Working Paper 0320, Federal Reserve Bank of Cleveland.
  12. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  13. James B. Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  14. Gisle James Natvik, 2006. "Government Spending and the Taylor Principle," Working Paper 2006/11, Norges Bank.
  15. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  16. Sveen, Tommy & Weinke, Lutz, 2005. "New perspectives on capital, sticky prices, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 123(1), pages 21-39, July.
  17. Jess Benhabib & Stefano Eusepi, 2005. "The design of monetary and fiscal policy: a global perspective," Proceedings, Federal Reserve Bank of San Francisco.
  18. Schmitt-Grohé, Stephanie & Uribe, Martín, 2005. "Optimal Inflation Stabilization in a Medium-Scale Macroeonomic Model," CEPR Discussion Papers 5424, C.E.P.R. Discussion Papers.
  19. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  20. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, vol. 98(1), pages 85-113, May.
  21. Tommy Sveen & Lutz Weinke, 2004. "Pitfalls in the modeling of forward-looking price setting and investment decisions," Economics Working Papers 773, Department of Economics and Business, Universitat Pompeu Fabra.
  22. Sveen, Tommy & Weinke, Lutz, 2007. "Lumpy investment, sticky prices, and the monetary transmission mechanism," Journal of Monetary Economics, Elsevier, vol. 54(Supplemen), pages 23-36, September.
  23. Kurozumi, Takushi & Van Zandweghe, Willem, 2008. "Investment, interest rate policy, and equilibrium stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1489-1516, May.
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