Taylor Rules in a Limited Participation Model
We use the limited participation model of money as a laboratory for studying the operating characteristics of Taylor rules for setting the rate of interest. Rules are evaluated according to their ability to protect the economy from bad outcomes such as the burst of inflation observed in the 1970s. Based on our analysis, we argue for a rule which: (i) raises the nominal interest rate more than one-for-one with a rise in inflation; and (ii) does not change the interest rate in response to a change in output relative to trend.
Published as "Sticky Price and Limited Participation Models of Money: A Comparison", European Economic Review, Vol. 41, no. 6 (June 1997): 1201-12 49.