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Inflation and output in New Keynesian models with a transient interest rate peg

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  • Charles T Carlstrom
  • Timothy S Fuerst
  • Matthius Paustian

Abstract

Recent monetary policy experience suggests a simple diagnostic for models of monetary non-neutrality. Suppose the central bank pegs the nominal interest rate below steady state for a reasonably short period of time. Familiar intuition suggests that this should be modestly inflationary, and a reasonable model should deliver such a prediction. We pursue this simple diagnostic in several variants of the familiar Dynamic New Keynesian (DNK) model. Some variants of the model produce counterintuitive inflation reversals where the effect of the interest rate peg can switch from highly inflationary to highly deflationary for only modest changes in the length of the interest rate peg. Curiously, this unusual behavior does not arise in a sticky information model of the Phillips curve.

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Paper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 1234.

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Date of creation: 2012
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Handle: RePEc:fip:fedcwp:1234

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Keywords: Time-series analysis ; Business cycles;

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  1. Stefan Laséen & Lars E.O. Svensson, 2011. "Anticipated Alternative policy Rate Paths in Plicy Simulations," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 7(3), pages 1-35, September.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Jun.
  3. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2009. "When is the government spending multiplier large?," NBER Working Papers 15394, National Bureau of Economic Research, Inc.
  4. Smets, Frank & Wouters, Raf, 2007. "Shocks and frictions in US business cycles: a Bayesian DSGE approach," Working Paper Series, European Central Bank 0722, European Central Bank.
  5. Lena Mareen Koerber & R. Anton Braun, 2010. "New Keynesian Dynamics in a Low Interest Rate Environment," 2010 Meeting Papers, Society for Economic Dynamics 531, Society for Economic Dynamics.
  6. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model: Expanded Version," NBER Working Papers 11417, National Bureau of Economic Research, Inc.
  7. Levin, Andrew & López-Salido, J David & Nelson, Edward & Yun, Tack, 2009. "Limitations on the Effectiveness of Forward Guidance at the Zero Lower Bound," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7581, C.E.P.R. Discussion Papers.
  8. Blake, Andrew, 2012. "Fixed interest rates over finite horizons," Bank of England working papers, Bank of England 454, Bank of England.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. The Macroeconomic Effects of Forward Guidance
    by Blog Author in Liberty Street Economics on 2013-02-25 12:00:00
  2. The Macroeconomic Effects of Forward Guidance
    by Barry Ritholtz in The Big Picture on 2013-02-26 11:00:36

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