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Inflation, Real Interest, and the Determinacy of Equilibrium in an Optimizing Framework

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  • Maurice Obstfeld

Abstract

This paper examines the short-run relation between anticipated inflation and the real rate of interest in a model where agents with perfect foresight maximize utility over infinite lifetimes. In addition to deriving behavioral functions from explicit intertemporal optimization, the approach taken here departs from the usual IS-LM analysis in that it is dynamic and deals with a small economy open to trade in consumption goods. Because capital mobility must be ruled out to allow scope for variation in the real interest rate, the results obtained here for one of the two exchange- rate regimes considered -- free floating -- apply equally to a closed economy. The paper shows that an increase in the expected inflation rate depresses the real interest rate in the short run when the exchange rate is instantaneously fixed by the central bank. When equilibrium is determinate in the floating-rate case, the real interest rate is invariant with respect to inflation.

Suggested Citation

  • Maurice Obstfeld, 1981. "Inflation, Real Interest, and the Determinacy of Equilibrium in an Optimizing Framework," NBER Working Papers 0723, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0723
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    References listed on IDEAS

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    1. Fischer, Stanley, 1979. "Capital Accumulation on the Transition Path in a Monetary Optimizing Model," Econometrica, Econometric Society, vol. 47(6), pages 1433-1439, November.
    2. Blanchard, Olivier J, 1979. "Backward and Forward Solutions for Economies with Rational Expectations," American Economic Review, American Economic Association, vol. 69(2), pages 114-118, May.
    3. Brock, William A., 1975. "A simple perfect foresight monetary model," Journal of Monetary Economics, Elsevier, vol. 1(2), pages 133-150, April.
    4. Brock, William A, 1974. "Money and Growth: The Case of Long Run Perfect Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 15(3), pages 750-777, October.
    5. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71, pages 280-280.
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    Cited by:

    1. Obstfeld, Maurice & Rogoff, Kenneth, 1983. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 675-687, August.
    2. Guglielmo Maria Caporale & Thouraya Hadj Amor & Christophe Rault, 2011. "Sources of Real Exchange Rate Volatility and International Financial Integration: A Dynamic GMM Panel Approach," CESifo Working Paper Series 3645, CESifo Group Munich.

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