Taylor-Type Rules and Permanent Shifts in Productivity Growth
Federal Reserve Bank of St. Louis Working Paper No. 2009-049A
29 Pages Posted: 1 Oct 2009
Date Written: September 30, 2009
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.
Keywords: Inflation Dynamics, Permanent Productivity Shocks, Nominal Interest Rate Rules
JEL Classification: E30, E42, E58
Suggested Citation: Suggested Citation