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How inflationary is an extended period of low interest rates?


  • Carlstrom, Charles T.
  • Fuerst, Timothy S.
  • Paustian, Matthias

    () (Federal Reserve Bank of Cleveland)


Recent monetary policy experience suggests a simple test of 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 inflationary. But a monetary model should be rejected if a reasonably short nominal rate peg results in an unreasonably large inflation response. We pursue this simple test in three variants of the familiar dynamic new Keynesian (DNK) model. All of these models fail this test. Further some variants of the model produce inflation reversals where an interest rate peg leads to sharp deflations.

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  • Carlstrom, Charles T. & Fuerst, Timothy S. & Paustian, Matthias, 2012. "How inflationary is an extended period of low interest rates?," Working Paper 1202, Federal Reserve Bank of Cleveland.
  • Handle: RePEc:fip:fedcwp:1202

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    References listed on IDEAS

    1. Blake, Andrew, 2012. "Fixed interest rates over finite horizons," Bank of England working papers 454, Bank of England.
    2. Mikhail Golosov & Robert E. Lucas Jr., 2007. "Menu Costs and Phillips Curves," Journal of Political Economy, University of Chicago Press, vol. 115, pages 171-199.
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    Cited by:

    1. Negro, Marco Del & Schorfheide, Frank, 2013. "DSGE Model-Based Forecasting," Handbook of Economic Forecasting, Elsevier.
    2. repec:bla:jecsur:v:31:y:2017:i:3:p:678-711 is not listed on IDEAS
    3. D'Amico, Stefania & King, Thomas B., 2015. "What Does Anticipated Monetary Policy Do?," Working Paper Series WP-2015-10, Federal Reserve Bank of Chicago.
    4. Richhild Moessner & David-Jan Jansen & Jakob de Haan, 2017. "Communication About Future Policy Rates In Theory And Practice: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 31(3), pages 678-711, July.
    5. P. Andrade & G. Gaballo & E. Mengus & B. Mojon, 2015. "Forward Guidance and Heterogeneous Beliefs," Working papers 573, Banque de France.
    6. Carrillo Julio A. & Poilly Céline, 2010. "Investigating the Zero Lower Bound on the Nominal Interest Rate under Financial Instability," Research Memorandum 019, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
    7. George-Marios Angeletos & Chen Lian, 2016. "Forward Guidance without Common Knowledge," NBER Working Papers 22785, National Bureau of Economic Research, Inc.

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    Interest rates; Interest rate risk;

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