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Working Paper

Taylor Rules in a Model that Satisfies the Natural Rate Hypothesis

This paper analyzes the restrictions necessary to ensure that the interest rate policy rule used by the central bank does not introduce real indeterminacy into the economy. It conducts this analysis in a flexible price economy and a sticky price model that satisfies the natural rate hypothesis. A necessary and sufficient condition for real determinacy in the sticky price model is for there to be nominal and real determinacy in the corresponding flexible price model. This arises if and only if the Taylor rule responds aggressively to lagged inflation rates.

Suggested Citation

Carlstrom, Charles T., and Timothy S. Fuerst. 2001. “Taylor Rules in a Model that Satisfies the Natural Rate Hypothesis.” Federal Reserve Bank of Cleveland, Working Paper No. 01-16.