Nominal and real interest rates during an optimal disinflation in New Keynesian models

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Nominal and real interest rates during an optimal disinflation in New Keynesian models

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Marcus Hagedorn () (Institut for Empirical Research (IEW), University of Zurich, Blümlisalpstrasse 10, CH-8006 Zürich, Switzerland.)

Abstract

Central bankers’ conventional wisdom suggests that nominal interest rates should be raised to implement a lower inflation target. In contrast, I show that the standard New Keynesian monetary model predicts that nominal interest rates should be decreased to attain this goal. Real interest rates, however, are virtually unchanged. These results also hold in recent vintages of New Keynesian models with sticky wages, price and wage indexation and habit formation in consumption. JEL Classification:

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Paper provided by European Central Bank in its series Working Paper Series with number 878.

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Length: 55 pages
Date of creation: Mar 2008
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Handle: RePEc:ecb:ecbwps:20080878

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This paper has been announced in the following NEP Reports:

NEP-ALL-2008-05-05 (All new papers)
NEP-CBA-2008-05-05 (Central Banking)
NEP-MAC-2008-05-05 (Macroeconomics)
NEP-MON-2008-05-05 (Monetary Economics)

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