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Generalizing the
Taylor Principle By Troy Davig and Eric
M. Leeper* |
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Abstract Abstract: Recurring change in a monetary policy
function that maps endogenous variables into policy choices alters both the
nature and the efficacy of the Taylor principle---the proposition that
central banks can stabilize the macroeconomy by raising their interest rate
instrument more than one-for-one in response to higher inflation. A monetary
policy process is a set of policy rules and a probability distribution over
the rules. We derive restrictions on that process that satisfy a long-run
Taylor principle and deliver unique equilibria in two standard models. A
process can satisfy the Taylor principle in the long run, but deviate from
it in the short run. The paper examines three empirically plausible
processes to show that predictions of conventional models are sensitive to
even small deviations from the assumption of constant-parameter policy
rules. Keywords: Taylor Rules, Monetary Policy, New Keynesian Model, Regime
Switching JEL classifications: E43, E52, E58 *This version: December 28, 2005. Research Department, Federal Reserve
Bank of Kansas City, Troy.Davig@kc.frb.org; Department of Economics, Indiana
University and NBER, eleeper@indiana.edu. We thank Mark Gertler for the
suggestions that spawned this paper. We also thank Gadi Barlevy, Marco
Bassetto, Steven Durlauf, Marty Eichenbaum, Roger Farmer, Jon Faust, David
Marshall, Tack Yun, Tao Zha and seminar participants Columbia University and
the Federal Reserve Banks of Chicago and Kansas City. Leeper acknowledges
support from NSF Grant SES-0452599. The views expressed herein are solely
those of the authors and do not necessarily reflect the views of the Federal
Reserve Bank of Kansas City or the Federal Reserve System.
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