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Working Paper

Inflation and Output in New Keynesian Models with a Transient Interest Rate Peg

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Recent monetary policy experience suggests a simple diagnostic for 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 modestly inflationary, and a reasonable model should deliver such a prediction. We pursue this simple diagnostic in several variants of the familiar Dynamic New Keynesian (DNK) model. Some variants of the model produce counterintuitive inflation reversals where the effect of the interest rate peg can switch from highly inflationary to highly deflationary for only modest changes in the length of the interest rate peg. Curiously, this unusual behavior does not arise in a sticky information model of the Phillips curve.
Topics
Inflation
Econometrics modeling and forecasting
12.16.2012ISSN 2573-7953 WP 12-34DOI 10.26509/frbc-wp-201234
Keywords fixed interest rates, new keynesian model, zero lower bound
JEL Classification Codes E32, C32

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Carlstrom, Charles T., Timothy S. Fuerst, and Matthius Paustian. 2012. “Inflation and Output in New Keynesian Models with a Transient Interest Rate Peg.” Federal Reserve Bank of Cleveland, Working Paper No. 12-34. https://doi.org/10.26509/frbc-wp-201234