Changes in the Inflation Target and the Comovement Between Inflation and the Nominal Interest Rate1

IF 1.1 4区 经济学 Q3 ECONOMICS Economic Record Pub Date : 2025-01-13 DOI:10.1111/1475-4932.12853
Yunjong Eo, Denny Lie
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Abstract

Would raising the inflation target require an increase in the nominal interest rate in the short run? We answer this policy question, first analytically in a small-scale New Keynesian model with backward-looking components where a closed-form solution exists, and then, in a medium-scale Smets and Wouters model calibrated to the US economy. Our analysis shows that the short-run comovement between inflation and the nominal interest rate conditional on changes in the inflation target is more likely to be positive, all else equal, as the monetary authority reacts less aggressively to the deviation of inflation from its target. Meanwhile, features of the model that enhance backward-looking behaviour, such as backward price indexation and habit formation in consumption, are shown to reduce the likelihood of the positive comovement. However, our investigations reveal that in both models, this positive comovement or the so-called Neo-Fisherism is prevalent across a wide range of empirically plausible parameter values. Using the Smets and Wouters model with a zero lower bound (ZLB) constraint on the nominal interest rate, we show that raising the inflation target could be an effective alternative policy framework to reduce the possibility of a binding ZLB constraint and to mitigate the potentially large output loss.

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来源期刊
Economic Record
Economic Record ECONOMICS-
CiteScore
1.90
自引率
16.70%
发文量
51
期刊介绍: Published on behalf of the Economic Society of Australia, the Economic Record is intended to act as a vehicle for the communication of advances in knowledge and understanding in economics. It publishes papers in the theoretical, applied and policy areas of economics and provides a forum for research on the Australian economy. It also publishes surveys in economics and book reviews to facilitate the dissemination of knowledge.
期刊最新文献
Issue Information News and Notices Changes in the Inflation Target and the Comovement Between Inflation and the Nominal Interest Rate1 The Legacy of the Global Financial Crisis, edited by Youssef Cassis and Jean-Jacques Helten (2023), 219 pages + xiv front matter Australia's Pandemic Exceptionalism: How We Crushed the Curve but Lost the Race, by Steven Hamilton and Richard Holden (UNSW Press, Sydney, 2024), pp. 228
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