Price Indexation, Habit Formation, and the Generalized Taylor Principle

Abstract

We prove that the Generalized Taylor Principle, under which the nominal interest rate reacts more than one-for-one to inflation in the long run, is a necessary and (under some extra mild restrictions on parameters) sufficient condition for determinacy in a sticky price model with positive steady-state inflation, interest rate smoothing in monetary policy, partial dynamic price indexation, and habit formation in consumption.

Keywords: determinacy, Generalized Taylor Principle, sticky prices, price indexation, habit formation, steady-state inflation

JEL Classification: E31, E52, E58