The Taylor principle fights back,Part II |
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Institution: | 1. Department of Mechanical and Industrial Engineering, Ryerson University, 350 Victoria Street, Toronto, ON, M5B 2K3, Canada;2. Department of Mechanical and Industrial Engineering, University of Toronto, 5 King’s College Road, Toronto, ON, M5S 3G8, Canada;1. School of Finance, Renmin University of China, China;2. Department of Economics, Chinese University of Hong Kong, Shatin, N.T., Hong Kong |
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Abstract: | The existing literature holds that the Taylor principle often leads to indeterminacy in New Keynesian models that allow for capital accumulation and limited asset market participation. This conclusion is special, however, to the case of continuous full employment. When the assumption of perfect wage flexibility is relaxed very slightly so that the labor market clears quickly but not instantaneously, determinacy is the norm. The threat of indeterminacy is limited to a tiny, irrelevant corner of the parameter space where the elasticity of labor supply is unusually high and real wage adjustment is unbelievably fast. Everywhere else, the Taylor principle guarantees a unique rational expectations equilibrium. The dramatic difference in results reflects the sensitivity of the monetary transmission mechanism to the speed of adjustment in the labor market. |
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Keywords: | Inflation Taylor principle Indeterminacy Limited asset market participation |
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