Labor market search, the Taylor principle, and indeterminacy

In a sticky-price model with labor market search and matching frictions, forecast-based interest rate policy almost always induces indeterminacy when it is strictly inflation targeting and satisfies the Taylor principle. Indeterminacy is due to a vacancy channel of monetary policy that makes inflation expectations self-fulfilling. The effect of this channel strengthens as the sluggishness of the adjustment of employment relative to that of consumption increases. When this relative sluggishness is high, the Taylor principle fails to ensure determinacy, regardless of whether the policy is forecast-based or outcome-based, whether it is strictly or flexibly inflation targeting, or contains policy rate smoothing. (C) 2010 Elsevier B.V. All rights reserved.