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Trend Inflation, Taylor Principle and Indeterminacy

Author

Listed:
  • Guido Ascari

    (Department of Economics and Quantitative Methods, University of Pavia)

  • Tiziano Ropele

    (Bank of Italy)

Abstract

Even low levels of trend inflation substantially affect the dynamics of a basic new Keynesian DSGE model when monetary policy is conducted by a contemporaneous Taylor rule. Positive trend inflation shrinks the determinacy region. Neither the Taylor principle, which requires the inflation coefficient to be greater than one, nor the generalized Taylor principle, which requires that in the long run the nominal interest rate should be raised by more than the increase in inflation, is a sufficient condition for local determinacy of equilibrium. This finding holds for different types of Taylor rules, inertial policy rules and price indexation schemes. Therefore, re- gardless of the theoretical set up, the monetary literature on Taylor rules cannot disregard average inflation in both theoretical and empirical analysis.

Suggested Citation

  • Guido Ascari & Tiziano Ropele, 2009. "Trend Inflation, Taylor Principle and Indeterminacy," Quaderni di Dipartimento 097, University of Pavia, Department of Economics and Quantitative Methods.
    • Handle: RePEc:pav:wpaper:097
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    Keywords

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    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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