The Effect of Conventional and Unconventional Monetary Policy Rules on Inflation Expectations: Theory and Evidence
AbstractThis paper has three parts. Part 1 constructs a classical economic model of inflation, augmented by a complete set of financial markets; I call this the core monetary model. Part 2 develops a series of calibrated examples to illustrate how the core monetary model explains the history of inflation after WWII and Part 3 provides evidence to show that the unconventional monetary policy, followed in the wake of the 2008 financial crisis, was effective in stabilizing inflation expectations. The core monetary model provides a unified framework to explain how an interest rule can be used to control inflation in normal times, and to explain the purpose of unconventional monetary policy when policy attains the zero lower bound. I argue that management of the variation in the composition of the Fed’s balance sheet, is an important tool in a central bank’s arsenal that can be used to help prevent deflation in the wake of a financial crisis.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8956.
Date of creation: May 2012
Date of revision:
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Other versions of this item:
- Roger E. A. Farmer, 2012. "The effect of conventional and unconventional monetary policy rules on inflation expectations: theory and evidence," Oxford Review of Economic Policy, Oxford University Press, vol. 28(4), pages 622-639, WINTER.
- Roger E.A. Farmer, 2012. "The Effect of Conventional and Unconventional Monetary Policy Rules on Inflation Expectations: Theory and Evidence," NBER Working Papers 18007, National Bureau of Economic Research, Inc.
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-05-29 (All new papers)
- NEP-CBA-2012-05-29 (Central Banking)
- NEP-HIS-2012-05-29 (Business, Economic & Financial History)
- NEP-MAC-2012-05-29 (Macroeconomics)
- NEP-MON-2012-05-29 (Monetary Economics)
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- Alexandros Kontonikas & Ronald MacDonald & Aman Saggu, 2012.
"Stock market reaction to fed funds rate surprises: state dependence and the financial crisis,"
2012_11, Business School - Economics, University of Glasgow.
- Kontonikas, Alexandros & MacDonald, Ronald & Saggu, Aman, 2013. "Stock market reaction to fed funds rate surprises: State dependence and the financial crisis," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4025-4037.
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