The Perverse Response of Interest Rates

Virginie Boinet and Christopher Martin

Economics and Finance Discussion Papers from Economics and Finance Section, School of Social Sciences, Brunel University

Abstract: We argue that an increase in aggregate demand can lead to a reduction in the interest rate.This apparently perverse optimal response of interest rates can occur when the Phillips curve is non-linear. In that case, an increase in aggregate demand tends to increase inflation and output but also to change the weight on inflation in the optimal monetary policy rule. Although the first two effects tend to increase interest rates, the latter effect can imply lower interest rates. If this effect dominates, interest rates can fall.

Pages: 10 pages
Date: 2006-06
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Journal Article: The perverse response of interest rates (2008)
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