The real heart of "Teddy" is the lengthy dialogue between Teddy and Nicholson. So much so, in fact, that the characters seem to exist only to embody certain philosophical ideas. Teddy embodies Eastern philosophy, Nicholson academic skepticism, and Mr. McArdle American capitalism and consumerism. Because the point of the story is ideas, and more particularly, philosophy, we can consider this philosophical fiction.
Literary Fiction is also an easy label when it comes to Salinger's work. He's one of the great American short story writers, and his relationship with The New Yorker – the crème de la crème of short story publications – is legendary. "Teddy" is one of the many Salinger narratives published in the magazine, and is exemplary of his craft and quality.