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

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  • Hagedorn, Marcus
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    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: E41, E43, E51, E52

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    Paper provided by European Central Bank in its series Working Paper Series with number 0878.

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    Date of creation: Mar 2008
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    Handle: RePEc:ecb:ecbwps:20080878

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    Keywords: Disinflation; nominal and real interest rates; optimal monetary policy;

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    1. Christopher J. Erceg and Andrew T. Levin, 2001. "Imperfect Credibility and Inflation Persistence," Computing in Economics and Finance 2001 19, Society for Computational Economics.
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    Cited by:
    1. Hagedorn, Marcus, 2011. "Optimal disinflation in new Keynesian models," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 248-261.

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