Expectations and the Neutrality of Interest Rates

John Cochrane

No 30468, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Our central banks set interest rates, and do not even pretend to control money supplies. How do interest rates affect inflation? We finally have a complete theory of inflation under interest rate targets and unconstrained liquidity. Its long-run properties mirror those of monetary theory: Inflation can be stable and determinate under interest rate targets, including a peg, analogous to a k-percent rule. The zero bound era is confirmatory evidence. Uncomfortably, stability means that higher interest rates eventually raise inflation, just as higher money growth eventually raises inflation. Sticky prices generate some short-run non-neutrality as well: Higher nominal interest rates can raise real rates and lower output. A model in which higher nominal interest rates temporarily lower inflation, without a change in fiscal policy, is a harder task. I exhibit one such model, but it paints a much more limited picture than standard beliefs. We either need a model with a stronger effect, or to accept that higher interest rates have limited power to lower inflation. Empirical understanding of how interest rates affect inflation without fiscal help is also a wide-open question.

JEL-codes: E4 E5 (search for similar items in EconPapers)
Date: 2022-09
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mon
Note: AP EFG
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Published as John H. Cochrane, 2024. "Expectations and the Neutrality of Interest Rates," Review of Economic Dynamics, .

Downloads: (external link)
http://www.nber.org/papers/w30468.pdf (application/pdf)

Related works:
Journal Article: Expectations and the Neutrality of Interest Rates (2024)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:30468

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w30468

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().