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American Economic Review: Vol. 97 No. 3 (June 2007)
AER Volume. 97, Issue 3 | 
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Generalizing the Taylor Principle
Article Citation
Davig, Troy, and
Eric M. Leeper. 2007. "Generalizing the Taylor Principle."
American Economic Review,
97(3): 607-635.
DOI: 10.1257/aer.97.3.607
DOI: 10.1257/aer.97.3.607
Abstract
The paper generalizes the Taylor principle—the proposition that central banks can
stabilize the macroeconomy by raising their interest rate instrument more than
one-for-one in response to higher inflation—to an environment in which reaction
coefficients in the monetary policy rule change regime, evolving according to a
Markov process. We derive a long-run Taylor principle which delivers unique
bounded equilibria in two standard models. Policy can satisfy the Taylor principle
in the long run, even while deviating from it substantially for brief periods or
modestly for prolonged periods. Macroeconomic volatility can be higher in periods
when the Taylor principle is not satisfied, not because of indeterminacy, but because
monetary policy amplifies the impacts of fundamental shocks. Regime change alters
the qualitative and quantitative predictions of a conventional new Keynesian model,
yielding fresh interpretations of existing empirical work. (JEL E31, E43, E52)
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Authors
Davig, Troy
Leeper, Eric M.
Leeper, Eric M.
