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Inflation surprises in a New Keynesian economy with a true consumption function. The Eurozone as an inflation target zone

Author

Listed:
  • Roberto Tamborini

Abstract

The resurgence of inflation since late 2021 is now accompanied by a reversal of prospects of growth, reviving fears of stagflation across the world (IMF 2022, World Bank 2022). In almost all accounts of the mounting stagflation threats, a prominent role is played by the fall of households purchasing power, and hence consumption, due to the inflation shock vis-Ã vis lagging nominal wages. This paper addresses the theoretical puzzle as to why this endogenous real income effect of inflation surprises, independent of restrictive monetary policy, is not present in the standard New Keynesian models for monetary policy. The paper shows how this channel can be introduced by reformulating the consumption function, with the consequence that it endogenously exerts a stabilisation effect on inflation. By means of simulations the paper discusses the main monetary policy implication: what is the role left to monetary policy intended to curb inflation in the same way?

Suggested Citation

  • 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.
    • Handle: RePEc:trn:utwprg:2023/1
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications
    • 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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