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The real interest rate gap as an inflation indicator

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  • Katharine S. Neiss
  • Edward Nelson

Abstract

A long-standing area of research and policy interest is the construction of a measure of monetary policy stance. One measure that has been proposed, as an alternative to indices that employ monetary aggregates or exchange rates, is the spread between the actual real interest rate and its flexible-price, or natural-rate, counterpart. This study examines the properties of the natural real interest rate and 'real interest rate gap' using a dynamic stochastic general equilibrium model. Issues investigated include: (1) the response of the gap and its components to fundamental economic shocks; and (2) the indicator and forecasting properties of the real interest gap for inflation, both in the model and in the data. The results suggest that the real interest rate gap has value as an inflation indicator, supporting the 'neo-Wicksellian framework' advocated by Woodford.

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Paper provided by Bank of England in its series Bank of England working papers with number 130.

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Date of creation: Apr 2001
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Handle: RePEc:boe:boeewp:130

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