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Taylor-type rules and permanent shifts in productivity growth

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  • William T. Gavin
  • Benjamin D. Keen
  • Michael R. Pakko

Abstract

This paper examines the impact of a permanent shock to the productivity growth rate in a New Keynesian model when the central bank does not immediately adjust its policy rule to that shock. Our results show that inflation and productivity growth are negatively correlated at business cycle frequencies when the central bank follows a Taylor-type policy rule that targets the output gap. We then demonstrate that inflation is more stable after a permanent productivity shock when monetary policy targets the output growth rate (not the output gap) or the price-level path (not the inflation rate). As for the welfare implications, both the output growth and price-level path rules generate much less volatility in output and inflation after a productivity shock than occurs with the Taylor rule.

Suggested Citation

  • William T. Gavin & Benjamin D. Keen & Michael R. Pakko, 2009. "Taylor-type rules and permanent shifts in productivity growth," Working Papers 2009-049, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2009-049
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    File URL: http://research.stlouisfed.org/wp/2009/2009-049.pdf
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    References listed on IDEAS

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    4. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters,in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
    5. Michael R. Pakko, 2002. "What Happens When the Technology Growth Trend Changes?: Transition Dynamics, Capital Growth and the 'New Economy'," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(2), pages 376-407, April.
    6. Michael T. Kiley, 2003. "Why Is Inflation Low When Productivity Growth Is High?," Economic Inquiry, Western Economic Association International, vol. 41(3), pages 392-406, July.
    7. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters,in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
    8. Francis, Neville & Ramey, Valerie A., 2005. "Is the technology-driven real business cycle hypothesis dead? Shocks and aggregate fluctuations revisited," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1379-1399, November.
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    13. Taylor, John B., 1999. "The robustness and efficiency of monetary policy rules as guidelines for interest rate setting by the European central bank," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 655-679, June.
    14. Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141.
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    Cited by:

    1. Anthony Diercks, 2016. "The Equity Premium, Long-Run Risk, and Optimal Monetary Policy," 2016 Meeting Papers 207, Society for Economic Dynamics.

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    Keywords

    Taylor's rule ; Productivity ; Inflation (Finance);

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