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Raise Rates to Raise Inflation? Neo-Fisherianism in the New Keynesian Model

Julio Garín, Robert Lester, Eric Sims

NBER Working Paper No. 22177
Issued in April 2016
NBER Program(s):Economic Fluctuations and Growth, Monetary Economics

Increasing the inflation target in a textbook New Keynesian (NK) model may require increasing, rather than decreasing, the nominal interest rate in the short run. We refer to this positive short run co-movement between the nominal interest rate and inflation conditional on a nominal shock as Neo-Fisherianism. We show that the NK model is more likely to be Neo-Fisherian the more persistent is the change in the inflation target and the more flexible are prices. Neo-Fisherianism is driven by the forward-looking nature of the model. Modifications which make the framework less forward-looking make it less likely for the model to exhibit Neo-Fisherianism. As an example, we show that a modest and empirically realistic fraction of "rule of thumb" price-setters may altogether eliminate Neo-Fisherianism in the textbook model.

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Document Object Identifier (DOI): 10.3386/w22177

Published: JULIO GARÍN & ROBERT LESTER & ERIC SIMS, 2018. "Raise Rates to Raise Inflation? Neo-Fisherianism in the New Keynesian Model," Journal of Money, Credit and Banking, vol 50(1), pages 243-259.

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