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The New Consensus in Monetary Policy: Is the NKM fit for the purpose of inflation targeting?

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  • Peter N. Smith

  • Mike Wickens

Abstract

In this paper we examine whether or not the NKM is .t for the purpose of providing a suitable basis for the conduct of monetary policy through inflation targeting. We focus on a number of issues: the dynamic response of inflation to interest rates in a theoretical NKM under discretion and commitment to a Taylor rule; the implications for the specification of the New Keynesian Phillips equation of alternative models of imperfect competition in a closed and an open economy; the general equilibrium underpinnings of the IS function; the extent of empirical support for the NKM; what the empirical evidence on the NKM implies for inflation targeting. Our findings reveal a number of problems with the NKM. Theoretically, the NKM predicts that a discretionary increase in interest rates will increase inflation, not reduce it. This is supported by our VAR evidence. Estimates of the NKM indicate a negative relation between interest rates and inflation, but the signs in the structural equations are inconsistent with the theory. We conclude that the standard specifications of the inflation and output equations are inadequate and that these equations should be embedded in a larger model.

Suggested Citation

  • Peter N. Smith & Mike Wickens, 2006. "The New Consensus in Monetary Policy: Is the NKM fit for the purpose of inflation targeting?," CDMA Conference Paper Series 0610, Centre for Dynamic Macroeconomic Analysis.
    • Handle: RePEc:san:cdmacp:0610
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    File URL: https://www.st-andrews.ac.uk/CDMA/papers/cp0610.pdf
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    Cited by:

    1. Francesco Saraceno & Roberto Tamborini, 2015. "How can it work ? On the impact of quantitative easing in the Eurozone," SciencePo Working papers Main hal-03470075, HAL.
    2. Roberto Tamborini, 2024. "Inflation surprises in a New Keynesian economy with a “true” consumption function," Economic Inquiry, Western Economic Association International, vol. 62(3), pages 1192-1215, July.
    3. repec:hal:spmain:info:hdl:2441/4ei7u710bj9par121c71ul9fdr is not listed on IDEAS
    4. Ronny Mazzocchi, 2013. "Investment-Saving Imbalances with Endogenous Capital Stock," DEM Discussion Papers 2013/14, Department of Economics and Management.
    5. Roberto Tamborini, 2023. "Inflation surprises in a New Keynesian economy with a true consumption function. The Eurozone as an inflation target zone," DEM Working Papers 2023/1, Department of Economics and Management.
    6. Yoshiyasu Ono, 2008. "Determinacy of Equilibrium under Various Phillips Curves," ISER Discussion Paper 0706, Institute of Social and Economic Research, The University of Osaka.
    7. repec:spo:wpmain:info:hdl:2441/4ei7u710bj9par121c71ul9fdr is not listed on IDEAS

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    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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