Do Higher Involvement Rates Heighten Or Lower Inflation?
The fact that inflation is hence stable when involvement rates are stuck at nix has profound implications. If inflation is stable at a nix peg, it must live on stable at a higher peg every bit well, which agency raising involvement rates must sooner or afterward heighten inflation. The opened upward question, which this newspaper goes after, is whether inflation tin sack temporarily reject when involvement rates rise. (Graphs from an before spider web log post service here.)
Classical "Keynesian" or "Monetarist" models tell that inflation is unstable inwards a peg. They must live on wrong. "New-Keynesian" models tell that inflation is stable inwards a peg, a skillful signal inwards their favor. The of import deviation is rational expectations. If people displace a machine looking inwards the nurture thought mirror, cars are unstable as well as veer off the road. If people aspect forward, hence cars are stable as well as larn dorsum on the route on their own.
But the measure new-Keynesian model besides predicts that inflation goes upward if involvement rates rise, every bit shown inwards the graph. Interest rates are blue, inflation is red, output is black. The dashed trouble is when people know the ascent is coming, the enterprise trouble for when it's a surprise. Raising rates does lower output, but every bit yous thought.
The newspaper tries everything to revive the thought that higher involvement rates lower inflation, without luck.
The measure new-Keynesian model accounts good for the fact that inflation has been stable at a nix involvement charge per unit of measurement peg. However, If the Fed raises nominal involvement rates, the same model model predicts that inflation volition smoothly rise, both inwards the curt run as well as long run. This newspaper presents a serial of failed attempts to escape this prediction. Sticky prices, money, backward-looking Phillips curves, choice equilibrium pick rules, as well as active Taylor rules create non convincingly overturn the result. The prove for lower inflation is weak. Perhaps both theory as well as information are trying to tell us that, when weather including adequate fiscal-monetary coordination operate, pegs tin sack live on stable as well as inflation responds positively to nominal involvement charge per unit of measurement increases.
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