Where Is the Natural Rate? Rational Policy Mistakes and Persistent Deviations of Inflation from Target
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Ricardo Reis
Empirical research has shown that there is large uncertainty concerning the value of the natural rate of unemployment at any point in time. I incorporate this feature in a model of monetary policy where the policymaker targets an inflation rate and the natural rate of unemployment and solve for the optimal policy. Two interesting results emerge. First, under a realistic shock profile, the model generates long-lasting deviations of inflation from target, providing an alternative (but also a complement) to the popular Barro-Gordon framework. Second, the economy exhibits large inflation persistence and can have very rich inflation dynamics. The model is able to account for approximately one third of the increase in inflation in the United States in the late 1970s, and suggests an explanation for the low inflation of the late 1990s. Moreover, I present empirical evidence for the United States and other countries that support the model including a new empirical finding: across countries there is a positive statistical relation between the persistence of unemployment and the persistence of inflation.
©2011 Walter de Gruyter GmbH & Co. KG, Berlin/Boston
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- An Analytical Approach to the Welfare Cost of Business Cycles and the Benefit from Activist Monetary Policy
- Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules
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- The Money Metric, Price and Quantity Aggregation and Welfare Measurement
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- Explaining Movements in the Labor Share
- Endogenous Growth with Intertemporally Dependent Preferences
- On the Friedman Rule in Search Models with Divisible Money
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- Advances Article
- Where Is the Natural Rate? Rational Policy Mistakes and Persistent Deviations of Inflation from Target
- Downward Nominal Wage Rigidity: Evidence from the Employment Cost Index
Articles in the same Issue
- Topics Article
- Balance of Payments Constrained Non-Scale Growth and the Population Puzzle
- The Human Capital Constraint: Of Increasing Returns, Education Choice and Coordination Failure
- ``To Furnish an Elastic Currency'': Banking, Aggregate Risk, and Welfare
- How Prudent are Community Representative Consumers?
- Price Distribution in a Symmetric Economy
- The Role of Stock Markets in Current Account Dynamics: a Time Series Approach
- Shiftwork, Adjustment Costs and Uncertainty
- How Do Future Constraints Affect Current Investment?
- The Politics of Endogenous Growth
- Sticky Prices, Coordination and Enforcement
- Fractional Integration with Bloomfield Disturbances in the Specification of Real Output in the G7 Countries
- Monetary Policy When the Nominal Short-Term Interest Rate is Zero
- High-Tech Human Capital: Do the Richest Countries Invest the Most?
- Substitution Elasticities and Investment Dynamics in Two-Country Business Cycle Models
- Contributions Article
- On Modeling the Effects of Inflation Shocks: Comments and Some Further Evidence
- Optimal Monetary Policy and the Correlation between Prices and Output
- Are Banking Supervisory Data Useful for Macroeconomic Forecasts?
- An Analytical Approach to the Welfare Cost of Business Cycles and the Benefit from Activist Monetary Policy
- Interpreting the Significance of the Lagged Interest Rate in Estimated Monetary Policy Rules
- Idle Capital and Long-Run Productivity
- The Money Metric, Price and Quantity Aggregation and Welfare Measurement
- Parente and Prescott's Theory May Work in Practice But Does Not Work in Theory
- Explaining Movements in the Labor Share
- Endogenous Growth with Intertemporally Dependent Preferences
- On the Friedman Rule in Search Models with Divisible Money
- Finance Causes Growth: Can We Be So Sure?
- Advances Article
- Where Is the Natural Rate? Rational Policy Mistakes and Persistent Deviations of Inflation from Target
- Downward Nominal Wage Rigidity: Evidence from the Employment Cost Index
