Informational inertia and the Taylor principle

Highlights • The Taylor principle is necessary, not just sufficient, when long-run Phillips curves are vertical. • Current inflation targeting alone determines equilibrium uniqueness. • Output gap targeting cannot replace a strong response to current inflation. • Models with vertical long-run Phillips curves share common determinacy conditions. • Information frictions tighten determinacy conditions relative to sticky prices. Abstract The Taylor principle, a more than one-for-one reaction of the nominal interest rate to inflation, is a central tenet of monetary policy to rule out self-fulfilling equilibria. The standard sticky-price model only holds this principle as a sufficient determinacy bound, with substitutes such as output-gap targeting available. We show that if the long-run Phillips curve is vertical, the Taylor principle is necessary and no amount of output-gap, output-growth, or forecast targeting can substitute for the vigorous response to inflation it prescribes. Sticky price models report determinacy bounds as generically model-dependent, nonlinear functions of model parameters. We find that models with vertical long-run Phillips curves share the same determinacy bounds despite differing short-run tradeoffs. These bounds are more conservative, placing tighter restrictions on monetary policy, and more robust, being independent of model-specific parameters and depending solely on monetary policy’s reaction to current inflation.