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The Taylor Principle and (In-) Determinacy in a New Keynesian Model with hiring Frictions and Skill Loss

  • Rannenberg, Ansgar

We introduce duration dependent skill decay among the unemployed into a New-Keynesian model with hiring frictions developed by Blanchard/Gali (2008). If the central bank responds only to (current, lagged or expected future) inflation and quarterly skill decay is above a threshold level, determinacy requires a coefficient on inflation smaller than one. The threshold level is plausible with little steady-state hiring and firing ("Continental European Calibration") but implausibly high in the opposite case ("American calibration"). Neither interest rate smoothing nor responding to the output gap helps to restore determinacy if skill decay exceeds the threshold level. However, a modest response to unemployment guarantees determinacy. Moreover, under indeterminacy, both an adverse sunspot shock and an adverse technology shock increase unemployment extremely persistently.

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File URL: http://hdl.handle.net/10943/86
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Paper provided by Scottish Institute for Research in Economics (SIRE) in its series SIRE Discussion Papers with number 2009-48.

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Date of creation: 2009
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Handle: RePEc:edn:sirdps:86
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