0 1 1 6 Taylor Rules in a Model that Satisfies the Natural Rate

Working papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views stated herein are those of the authors and are not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. 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.