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INVESTMENT AND FORWARD-LOOKING MONETARY POLICY: A WICKSELLIAN SOLUTION TO THE PROBLEM OF INDETERMINACY

  • Stephen McKnight (a1)
Abstract

Recent research has shown that forward-looking Taylor rules are subject to indeterminacy in New Keynesian models with capital and investment spending. This paper shows that adopting a forward-looking Wicksellian rule that responds to the price level, rather than to inflation, is one potential remedy for the indeterminacy problem. This result is shown to be robust to variations in both the labor supply elasticity and the degree of price stickiness, the inclusion of capital adjustments costs, and if output also enters into the interest-rate feedback rule. Finally, it is shown that the superiority of Wicksellian rules over Taylor rules is not only confined to forward-looking policy, but also extends to both backward-looking and contemporaneous-looking specifications of the monetary policy rule.

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Corresponding author
Address correspondence to: Stephen McKnight, Centro de Estudios Económicos, El Colegio de México, Camino al Ajusco 20, Pedregal de Santa Teresa, Mexico City 10740, Mexico; e-mail: mcknight@colmex.mx.
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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
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