Fiscal Deficits, Taylor Rules, and Price Dynamics

This paper reconsiders the issue of price level determination under interest rate feedback rules using an optimizing general equilibrium framework with overlapping generations and flexible prices. The analysis shows that under fiscal shocks, monetary policy commitment to instrument rules of the Taylor-type might be insufficient for inflation control. It is also demonstrated that the existence of a unique stable equilibrium path for the price level does not require active monetary rules.The author wishes to thank an anonymous referee, Barbara Annicchiarico, Giuseppe De Arcangelis, Giancarlo Marini, and Giorgio Rodano for useful comments and suggestions.The usual disclaimer applies.