A Keynesian angle for the Taylor rule: mortgage rates, monthly payment illusion, and the scarecrow effect of inflation

Alan Haight

Journal of Post Keynesian Economics, 2007, vol. 30, issue 2, 259-277

Abstract: Without a little inflation, bad investment drives out good. Moderate inflation enhances productivity by functioning like a scarecrow: the rise in nominal mortgage rates deters myopic home buyers, who naively watch the nominal interest rate (in its guise as the payment-to-income ratio) rather than the real rate. The recent house price bubble is often blamed on predatory, subprime lending; but low inflation created an environment conducive to such practices. Here a modified IS curve is used to derive a schedule of the neutral real interest rate—where "neutral" has the meaning established by Keynes (1964, p. 243). This shows that, contrary to the Taylor principle, a stabilizing monetary policy reaction function can be flatter than 45 degrees. The central bank need not be as hawkish as is presumed by those who fear that inflation is everywhere and always a runaway phenomenon. Inflation-induced self-selection of borrowers can enhance growth. Overzealous central bank discipline can cause crowding out

Date: 2007
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DOI: 10.2753/PKE0160-3477300206

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