Raise Rates to Raise Inflation? Neo-Fisherianism in the New Keynesian Model
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.
We are grateful to John Cochrane, Tim Fuerst, Bill Lastrapes, and Ron Mau for helpful comments and discussions. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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. citation courtesy of