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Where Is the Natural Rate? Rational Policy Mistakes and Persistent Deviations of Inflation from Target

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Author Info

  • Ricardo Reis

    (Harvard University)

Abstract

Empirical research has shown that there is large uncertainty concerning the value of the natural rate of unemployment at any point in time. I incorporate this feature in a model of monetary policy where the policymaker targets an inflation rate and the natural rate of unemployment and solve for the optimal policy. Two interesting results emerge. First, under a realistic shock profile, the model generates long-lasting deviations of inflation from target, providing an alternative (but also a complement) to the popular Barro-Gordon framework. Second, the economy exhibits large inflation persistence and can have very rich inflation dynamics. The model is able to account for approximately one third of the increase in inflation in the United States in the late 1970s, and suggests an explanation for the low inflation of the late 1990s. Moreover, I present empirical evidence for the United States and other countries that support the model including a new empirical finding: across countries there is a positive statistical relation between the persistence of unemployment and the persistence of inflation.

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Bibliographic Info

Article provided by Berkeley Electronic Press in its journal The B.E. Journal of Macroeconomics.

Volume (Year): advances.3 (2003)
Issue (Month): 1 ()
Pages: 1
Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Handle: RePEc:bpj:bejmac:v:advances.3:y:2003:i:1:n:1

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Web page: http://www.bepress.com/bejm

For corrections or technical questions regarding this item, or to correct its listing, contact: (Nickolas Zeibig-Kichas).

Related research

Keywords: Monetary policy under uncertainty; Natural rate of unemployment; Inflation persistence.;

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Citations

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Cited by:
  1. Queijo von Heideken, Virginia, 2008. "Monetary Policy Regimes and the Volatility of Long-Term Interest Rates," Working Paper Series 220, Sveriges Riksbank (Central Bank of Sweden).
  2. Klaus Schmidt-Hebbel & Carl E. Walsh, 2009. "Monetary Policy and Key Unobservables: Evidence from Large Industrial and Selected Inflation-Targeting Countries," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.), Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 9, pages 285-370 Central Bank of Chile.
  3. Guido Lorenzoni, 2007. "News Shocks and Optimal Monetary Policy," NBER Working Papers 12898, National Bureau of Economic Research, Inc.
  4. Martin Ellison & Tony Yates, 2007. "Escaping Nash and volatile inflation," Bank of England working papers 330, Bank of England.
  5. Alan S. Blinder & Ricardo Reis, 2005. "Understanding the Greenspan Standard," Working Papers 88, Princeton University, Department of Economics, Center for Economic Policy Studies..
  6. Gersbach, Hans & Hahn, Volker, 2006. "Signaling And Commitment: Monetary Versus Inflation Targeting," Macroeconomic Dynamics, Cambridge University Press, vol. 10(05), pages 595-624, November.
  7. Richard Mash, 2004. "Optimising Microfoundations for Inflation Persistence," Economics Series Working Papers 183, University of Oxford, Department of Economics.
  8. Brian Snowdon, 2007. "The New Classical Counter-Revolution: False Path or Illuminating Complement?," Eastern Economic Journal, Eastern Economic Association, vol. 33(4), pages 541-562, Fall.
  9. Sharon Kozicki & P. Tinsley, 2006. "Minding the Gap: Central Bank Estimates of the Unemployment Natural Rate," Computational Economics, Society for Computational Economics, vol. 27(2), pages 295-327, May.
  10. Guido Lorenzoni, 2009. "A Theory of Demand Shocks," American Economic Review, American Economic Association, vol. 99(5), pages 2050-84, December.

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