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Interest‐Rate Pegs in New Keynesian Models

George Evans () and Bruce McGough ()

Journal of Money, Credit and Banking, 2018, vol. 50, issue 5, 939-965

Abstract: The conventional policy perspective is that lowering the interest rate increases output and inflation in the short run, while maintaining inflation at a higher level requires a higher interest rate in the long run. In contrast, it has been argued that a Neo‐Fisherian policy of setting an interest‐rate peg at a fixed higher level will increase the inflation rate. We show that adaptive learning argues against the Neo‐Fisherian approach. Pegging the interest rate at a higher level will induce instability and most likely lead to falling inflation and output over time. Eventually, this would precipitate a change of policy.

Date: 2018
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Handle: RePEc:wly:jmoncb:v:50:y:2018:i:5:p:939-965