Trend inflation, Taylor principle and indeterminacy

Guido Ascari () and Tiziano Ropele ()
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Tiziano Ropele: Bank of Italy, Economic Research Unit, Genova Branch

No 708, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research Department

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, regardless of the theoretical set up, the monetary literature on Taylor rules cannot disregard average inflation in both theoretical and empirical analysis.

Keywords: sticky prices; Taylor rules; trend inflation (search for similar items in EconPapers)
JEL-codes: E31 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2009-05
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Related works:
Working Paper: Trend Inflation, Taylor Principle and Indeterminacy (2007)
Working Paper: Trend Inflation, Taylor Principle and Indeterminacy (2005)
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Persistent link: http://EconPapers.repec.org/RePEc:bdi:wptemi:td_708_09

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