Firm-Specific Investment, Sticky Prices, and the Taylor Principle
UPF Economics and Business Working Paper 780
31 Pages Posted: 16 Nov 2005
Date Written: October 26, 2004
According to the Taylor principle a central bank should adjust the nominal interest rate by more than one-for-one in response to changes in current inflation. Most of the existing literature supports the view that by following this simple recommendation a central bank can avoid being a source of unnecessary fluctuations in economic activity. The present paper shows that this conclusion is not robust with respect to the modeling of capital accumulation. We use our insights to discuss the desirability of alternative interest rate rules. Our results suggest a reinterpretation of monetary policy under Volcker and Greenspan: The empirically plausible characterization of monetary policy can explain the stabilization of macroeconomic outcomes observed in the early eighties for the US economy. The Taylor principle in itself cannot.
Keywords: Sticky Prices, aggregate investment, monetary policy
JEL Classification: E22, E31
Suggested Citation: Suggested Citation