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Trend inflation and Monetary policy rules: Determinacy analyses in New Keynesian model with capital accumulation

Elena, Gerko and Kirill, Sossounov (2011): Trend inflation and Monetary policy rules: Determinacy analyses in New Keynesian model with capital accumulation.

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Abstract

The eects of positive trend inflation is analyzed in the framework of the standard New-Keynesian model with Calvo price setting and capital accumulation. It is build on the work of Duport (2001) and Ascari and Ropele (2007) who separately considered eects of capital accumulation and trend inflation in the similar context. It is shown that the simultaneous presence of positive inflation and capital accumulation greatly aects determinacy property of equilibrium in this setup. Namely, in order to maintain stability in addition to actively react to inflation monetary authorities should react to output uctuations but not to a great extend. Overreaction to output may lead to indeterminacy. We also show that for a large set of plausible parameters standard Taylor rule leads to indeterminacy. Alternative monetary policy rules are also analyzed.

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