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On Modeling the Effects of Inflation Shocks

  • Fair Ray C

    ()

    (Yale University)

A popular model in the literature postulates an interest rate rule, a NAIRU price equation, and an aggregate demand equation in which aggregate demand depends on the real interest rate. In this model a positive inflation shock with the nominal interest rate held constant is explosive because it increases aggregate demand (because the real interest rate is lower), which increases inflation through the price equation, which further increases aggregate demand, and so on. In order for the model to be stable, the nominal interest rate must rise more than inflation, which means that the coefficient on inflation in the interest rate rule must be greater than one.

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Article provided by De Gruyter in its journal The B.E. Journal of Macroeconomics.

Volume (Year): 2 (2002)
Issue (Month): 1 (April)
Pages: 1-21

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Handle: RePEc:bpj:bejmac:v:contributions.2:y:2002:i:1:n:3
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  1. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, June.
  2. David H. Romer, 2000. "Keynesian Macroeconomics without the LM Curve," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 149-169, Spring.
  3. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
  4. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  5. Robert J. Gordon & Stephen R. King, 1982. "The Output Cost of Disinflation in Traditional and Vector Autoregressive Models," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(1), pages 205-244.
  6. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  7. David Reifschneider & Robert Tetlow & John Williams, 1999. "Aggregate disturbances, monetary policy, and the macroeconomy: the FRB/US perspective," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-19.
  8. Ray C. Fair & John B. Taylor, 1980. "Solution and Maximum Likelihood Estimation of Dynamic Nonlinear RationalExpectations Models," NBER Technical Working Papers 0005, National Bureau of Economic Research, Inc.
  9. George L. Perry, 1980. "Inflation in Theory and Practice," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 207-260.
  10. Ray C. Fair, 2000. "Testing the NAIRU Model for the United States," The Review of Economics and Statistics, MIT Press, vol. 82(1), pages 64-71, February.
  11. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  12. Fair, Ray C, 1993. "Testing the Rational Expectations Hypothesis in Macroeconometric Models," Oxford Economic Papers, Oxford University Press, vol. 45(2), pages 169-90, April.
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