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On Modeling the Effects of Inflation Shocks

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  • Fair Ray C

    ()
    (Yale University)

Abstract

A popular model in the literature postulates an interest rate rule, a NAIRU price equation, and an aggregate demand equation in which aggregate demand depends on the real interest rate. In this model a positive inflation shock with the nominal interest rate held constant is explosive because it increases aggregate demand (because the real interest rate is lower), which increases inflation through the price equation, which further increases aggregate demand, and so on. In order for the model to be stable, the nominal interest rate must rise more than inflation, which means that the coefficient on inflation in the interest rate rule must be greater than one.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 2 (2002)
Issue (Month): 1 (April)
Pages: 1-21

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Handle: RePEc:bpj:bejmac:v:contributions.2:y:2002:i:1:n:3

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  1. David Romer, 2000. "Keynesian Macroeconomics without the LM Curve," NBER Working Papers 7461, National Bureau of Economic Research, Inc.
  2. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  3. Ray C. Fair & John B. Taylor, 1980. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rational Expectations Models," Cowles Foundation Discussion Papers 564, Cowles Foundation for Research in Economics, Yale University.
  4. Fair, Ray C, 1993. "Testing the Rational Expectations Hypothesis in Macroeconometric Models," Oxford Economic Papers, Oxford University Press, vol. 45(2), pages 169-90, April.
  5. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  6. Ray C. Fair, 2000. "Testing the NAIRU Model for the United States," The Review of Economics and Statistics, MIT Press, vol. 82(1), pages 64-71, February.
  7. George L. Perry, 1980. "Inflation in Theory and Practice," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 207-260.
  8. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  9. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  10. Robert J. Gordon & Stephen R. King, 1982. "The Output Cost of Disinflation in Traditional and Vector Autoregressive Models," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(1), pages 205-244.
  11. David Reifschneider & Robert Tetlow & John Williams, 1999. "Aggregate disturbances, monetary policy, and the macroeconomy: the FRB/US perspective," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-19.
  12. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
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Cited by:
  1. repec:ebl:ecbull:v:5:y:2006:i:19:p:1-7 is not listed on IDEAS
  2. Corrado, Luisa & Holly, Sean, 2003. "Nonlinear Phillips curves, mixing feedback rules and the distribution of inflation and output," Journal of Economic Dynamics and Control, Elsevier, vol. 28(3), pages 467-492, December.
  3. Ray C. Fair, 2006. "A Comparison of Five Federal Reserve Chairmen: Was Greenspan the Best?," Levine's Bibliography 321307000000000415, UCLA Department of Economics.
  4. W A Razzak, 2002. "Monetary policy and forecasting inflation with and without the output gap," Reserve Bank of New Zealand Discussion Paper Series DP2002/03, Reserve Bank of New Zealand.
  5. Barbara Annicchiarico & Alessandro Piergallini, 2006. "Inflation shocks and interest rate rules," Economics Bulletin, AccessEcon, vol. 5(19), pages 1-7.
  6. Shaun K. Roache & Alexander P. Attie, 2009. "Inflation Hedging for Long-Term Investors," IMF Working Papers 09/90, International Monetary Fund.
  7. Ray C. Fair, 2006. "Evaluating Inflation Targeting Using a Macroeconometric Model," Cowles Foundation Discussion Papers 1570, Cowles Foundation for Research in Economics, Yale University, revised Mar 2007.
  8. Alistair Dieppe & Jerome Henry & Peter Mc Adam, . "Labour market dynamics in the euro area: A model-based sensitivity analysis," Modeling, Computing, and Mastering Complexity 2003 09, Society for Computational Economics.
  9. Paul Turner, 2007. "Some UK evidence on the Forward Looking IS Equation:," Discussion Paper Series 2007_16, Department of Economics, Loughborough University, revised May 2007.
  10. Hillinger, Claude & Süssmuth, Bernd, 2008. "The Quantity Theory of Money is Valid. The New Keynesians are Wrong!," Discussion Papers in Economics 6987, University of Munich, Department of Economics.

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