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On Modeling the Effects of Inflation Shocks

Author

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  • Fair Ray C

    (Yale University)

Abstract

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.

Suggested Citation

  • Fair Ray C, 2002. "On Modeling the Effects of Inflation Shocks," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-21, April.
    • Handle: RePEc:bpj:bejmac:v:contributions.2:y:2002:i:1:n:3
    DOI: 10.2202/1534-6005.1045
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    Cited by:

    1. Paul Turner, 2007. "Some UK evidence on the Forward Looking IS Equation:," Discussion Paper Series 2007_16, Department of Economics, Loughborough University, revised May 2007.
    2. Ray C. Fair, 2006. "Evaluating Inflation Targeting Using a Macroeconometric Model," Levine's Bibliography 321307000000000303, UCLA Department of Economics.
    3. Fair Ray C, 2007. "A Comparison of Five Federal Reserve Chairmen: Was Greenspan the Best?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-27, June.
    4. Fair, Ray C., 2007. "Evaluating Inflation Targeting Using a Macroeconometric Model," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 1, pages 1-52.
    5. Alistair Dieppe & Jerome Henry & Peter Mc Adam, "undated". "Labour market dynamics in the euro area: A model-based sensitivity analysis," Modeling, Computing, and Mastering Complexity 2003 09, Society for Computational Economics.
    6. Hillinger, Claude & Süssmuth, Bernd, 2008. "The Quantity Theory of Money is Valid. The New Keynesians are Wrong!," Discussion Papers in Economics 6987, University of Munich, Department of Economics.
    7. Ray C. Fair, 2006. "A Comparison of Five Federal Reserve Chairmen: Was Greenspan the Best?," Levine's Bibliography 321307000000000415, UCLA Department of Economics.
    8. repec:ebl:ecbull:v:5:y:2006:i:19:p:1-7 is not listed on IDEAS
    9. Antonio Paradiso & Saten Kumar & B. Bhaskara Rao, 2013. "A New Keynesian IS curve for Australia: is it forward looking or backward looking?," Applied Economics, Taylor & Francis Journals, vol. 45(26), pages 3691-3700, September.
    10. Carola Binder, 2018. "Interest Rate Prominence In Consumer Decision‐Making," Economic Inquiry, Western Economic Association International, vol. 56(2), pages 875-894, April.
    11. Barbara Annicchiarico & Alessandro Piergallini, 2006. "Inflation shocks and interest rate rules," Economics Bulletin, AccessEcon, vol. 5(19), pages 1-7.
    12. Paolo Giordani, 2004. "Evaluating New‐Keynesian Models of a Small Open Economy," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(s1), pages 713-733, September.
    13. Corrado, Luisa & Holly, Sean, 2003. "Nonlinear Phillips curves, mixing feedback rules and the distribution of inflation and output," Journal of Economic Dynamics and Control, Elsevier, vol. 28(3), pages 467-492, December.
    14. W A Razzak, 2002. "Monetary policy and forecasting inflation with and without the output gap," Reserve Bank of New Zealand Discussion Paper Series DP2002/03, Reserve Bank of New Zealand.
    15. Mr. Shaun K. Roache & Alexander P. Attie, 2009. "Inflation Hedging for Long-Term Investors," IMF Working Papers 2009/090, International Monetary Fund.

    More about this item

    JEL classification:

    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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