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The Taylor principle fights back, Part II

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  • Buffie, Edward F.

Abstract

The existing literature holds that the Taylor principle often leads to indeterminacy in New Keynesian models that allow for capital accumulation and limited asset market participation. This conclusion is special, however, to the case of continuous full employment. When the assumption of perfect wage flexibility is relaxed very slightly so that the labor market clears quickly but not instantaneously, determinacy is the norm. The threat of indeterminacy is limited to a tiny, irrelevant corner of the parameter space where the elasticity of labor supply is unusually high and real wage adjustment is unbelievably fast. Everywhere else, the Taylor principle guarantees a unique rational expectations equilibrium. The dramatic difference in results reflects the sensitivity of the monetary transmission mechanism to the speed of adjustment in the labor market.

Suggested Citation

  • Buffie, Edward F., 2014. "The Taylor principle fights back, Part II," Journal of Economic Dynamics and Control, Elsevier, vol. 46(C), pages 30-49.
    • Handle: RePEc:eee:dyncon:v:46:y:2014:i:c:p:30-49
    DOI: 10.1016/j.jedc.2014.05.016
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    2. Edward F. Buffie & Manoj Atolia, 2016. "Fiscal Adjustment and Inflation Targeting in Less Developed Countries," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(8), pages 1839-1875, December.

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    More about this item

    Keywords

    Inflation; Taylor principle; Indeterminacy; Limited asset market participation;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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