Determinacy and Taylor’s Rule with Different Degrees of Trade Openness in a Semi-New Keynesian Model

Abstract

The determinacy question, concerning whether or not there is convergence to a unique equilibrium path, in an explicitly dynamic setting, has been addressed in closed economies but only scantily in an open one. We undertake this task, using a model that leads to a 4^th -degree characteristic equation which cannot be handled analytically; therefore, we develop a particular algorithm to solve it. We show that the determinacy-consistent specification of Taylor’s rule depends, critically, on the greater or lower openness in the trade sector. Greater openness supports a novel specification of Taylor’s rule with stronger emphasis on output gaps and weaker emphasis on the price stability than in earlier studies. Under this rule, determinate equilibrium dynamics is shown to be possible. When trade openness decreases significantly, determinacy is still possible, but it is compatible with a far more conventional formulation Taylor’s rule where price stability has absolute priority.