Rule-of-Thumb Consumers and the Design of Interest Rate Rules

Abstract

We introduce rule-of-thumb consumers in an otherwise standard dynamic sticky price model, and show how their presence can change dramatically the properties of widely used interest rate rules. In particular, the existence of a unique equilibrium is no longer guaranteed by an interest rate rule that satisfies the so-called Taylor principle. Our findings call for caution when using estimates of interest rate rules in order to assess the merits of monetary policy in specific historical periods.

Keywords: Taylor principle, interest rate rules, sticky prices, rule-of-thumb consumers

JEL Classification: E32, E52