Inflation Indexation and Zero Lower Bound

Daeha Cho and Eunseong Ma
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Daeha Cho: Hanyang University

No 2024rwp-233, Working papers from Yonsei University, Yonsei Economics Research Institute

Abstract: This study quantitatively assesses both the aggregate and disaggregate effects of inflation-indexed loan contracts using a heterogeneous agentNewKeynesian (HANK) model with an occasionally binding zero lower bound (ZLB). Substituting real for nominal government bonds reduces the volatility of output and inflation and decreases the frequency of ZLB events. Real loans sever the link between real interest rates and inflation, preventing a rise in real interest rates at the ZLB. Accordingly, ZLB events become less costly, weakening precautionary savings against aggregate risk. This leads to higher average nominal rates and a reduced frequency of ZLB occurrences, further reducing aggregate volatility. Although inflation indexation improves aggregate welfare, at the disaggregate level, the wealthy lose while the poor gain. Inflation indexation outperforms suggested policies aimed at providing more room for monetary policy, such as increasing the inflation target and implementing an asymmetric Taylor rule.

Keywords: Zero lower bound; HANK model; Inflation indexation; Welfare (search for similar items in EconPapers)
JEL-codes: D31 E31 E32 E52 (search for similar items in EconPapers)
Pages: 37pages
Date: 2024-10
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:yon:wpaper:2024rwp-233

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