Inflation surprises in a New Keynesian economy with a true consumption function. The Eurozone as an inflation target zone

Roberto Tamborini (roberto.tamborini@unitn.it)

No 2023/1, DEM Working Papers from Department of Economics and Management

Abstract: The resurgence of inflation since late 2021 is now accompanied by a reversal of prospects of growth, reviving fears of stagflation across the world (IMF 2022, World Bank 2022). In almost all accounts of the mounting stagflation threats, a prominent role is played by the fall of households purchasing power, and hence consumption, due to the inflation shock vis-Ã vis lagging nominal wages. This paper addresses the theoretical puzzle as to why this endogenous real income effect of inflation surprises, independent of restrictive monetary policy, is not present in the standard New Keynesian models for monetary policy. The paper shows how this channel can be introduced by reformulating the consumption function, with the consequence that it endogenously exerts a stabilisation effect on inflation. By means of simulations the paper discusses the main monetary policy implication: what is the role left to monetary policy intended to curb inflation in the same way?

Keywords: Cost-push inflation; real income effect; stagflation; New Keynesian models for monetary policy (search for similar items in EconPapers)
JEL-codes: E17 E3 E5 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:trn:utwprg:2023/1

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