Inflation Shocks and Interest Rate Rules
24 Pages Posted: 1 Aug 2006
Date Written: July 2006
Recent empirical evidence by Fair (2002,2005) and Giordani (2003) shows that a positive inflation shock with the nominal interest rate held constant has contractionary effects. These results cannot be reconciled with the standard 'New Synthesis' literature. This paper reconsiders the effects of inflation shocks in a simple New Keynesian framework extended to include wealth effects. It is demonstrated that, following an inflation shock, the decline of output coupled with passive interest rate rules is not puzzling.
Keywords: Interest Rate Rules, Nominal Rigidities, Overlapping Generations, Inflation Shocks
JEL Classification: E52, E58
Suggested Citation: Suggested Citation