Taylor-Type Rules and Total Factor Productivity

This paper examines the impact of a persistent shock to the growth rate of total factor productivity in a New Keynesian model in which the central bank does not observe the shock. The authors then investigate the performance of alternative policy rules in such an incomplete information environment. While some rules perform better than others, the authors demonstrate that inflation is more stable after a persistent productivity shock when monetary policy targets the output growth rate (not the output gap) or the price-level path (not the inflation rate). Both the output growth and price-level path rules generate less volatility in output and inflation following a persistent productivity shock compared with the Taylor rule. (JEL E30, E42, E58)