Premium
Monetary Policy, Taylor’s Rule and Instability
Author(s) -
González Luis Alberto Alonso,
Vera Alfonso Palacio
Publication year - 2002
Publication title -
metroeconomica
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.256
H-Index - 29
eISSN - 1467-999X
pISSN - 0026-1386
DOI - 10.1111/1467-999x.00132
Subject(s) - output gap , taylor rule , economics , inflation (cosmology) , monetary policy , interest rate , context (archaeology) , stability (learning theory) , econometrics , instability , stabilization policy , macroeconomics , mathematical economics , central bank , computer science , mechanics , physics , paleontology , machine learning , biology , theoretical physics
We analyse the dynamic behaviour of an economy where the central bank (CB) sets interest rates according to a Taylor‐type policy rule. A simple model for a closed and instability‐prone economy is constructed and subjected to formal dynamical analysis and numerical simulation. It is shown that a requirement for local stability is that the two response coefficients in the policy rule be positive. Similarly, it is shown that raising the response coefficient of the output gap increases the likeliness of the economy being stable, whereas raising the response coefficient of the inflation gap has an uncertain and probably negligible effect on local stability. Self‐sustained oscillations may arise for certain parameter values. Policy mistakes in the estimation of the long‐run equilibrium real interest rate or potential real GDP may prevent the CB from achieving its inflation target. A suggestion for enhancing the stabilization capacity of Taylor‐type policy rules in the context of the model presented is made.