Event Details

Title: Interest rates and inflation in New Keynesian models: the role of expectations

Abstract: How do interest rates affect inflation in New Keynesian models? Such a simple question has a complex answer, centered around the role of expectations. I offer some insights on this issue, related to the solution of rational expectations models, and propose a new condition for reasonable equilibria in purely forward looking models with positive expectational feedback, namely that expectations should not reverse the sign relationship between exogenous and endogenous variables as posited by economic theory in the structural model. In all such equilibria, higher interest rates lead to lower inflation, and real and nominal rates move in the same direction. Such equilibria exist and correspond to the forward solution of the model if a version of the Taylor principle is satisfied, which depends on the degree of persistence of the exogenous shocks. The same condition ensures that such equilibria are learnable under adaptive learning (E-stable).