The fact that inflation is thence stable when involvement rates are stuck at nil has profound implications. If inflation is stable at a nil peg, it must endure stable at a higher peg every bit well, which agency raising involvement rates must sooner or afterwards enhance inflation. The opened upwards question, which this newspaper goes after, is whether inflation tin forcefulness out temporarily refuse when involvement rates rise. (Graphs from an before weblog post service here.)
Classical "Keynesian" or "Monetarist" models tell that inflation is unstable inward a peg. They must endure wrong. "New-Keynesian" models tell that inflation is stable inward a peg, a skillful signal inward their favor. The of import departure is rational expectations. If people motility a motorcar looking inward the bring upwards sentiment mirror, cars are unstable as well as veer off the road. If people facial expression forward, thence cars are stable as well as larn dorsum on the route on their own.
But the criterion new-Keynesian model besides predicts that inflation goes upwards if involvement rates rise, every bit shown inward the graph. Interest rates are blue, inflation is red, output is black. The dashed business is when people know the rising is coming, the corporation business for when it's a surprise. Raising rates does lower output, but every bit you lot thought.
The newspaper tries everything to revive the thought that higher involvement rates lower inflation, without luck.
The criterion new-Keynesian model accounts good for the fact that inflation has been stable at a nil 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 inward 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, alternative equilibrium choice rules, as well as active Taylor rules produce non convincingly overturn the result. The show 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 forcefulness out endure stable as well as inflation responds positively to nominal involvement charge per unit of measurement increases.
