Working Paper: CEPR ID: DP15184
Authors: Paul Beaudry; Chenyu Hou; Franck Portier
Abstract: This papers begins by highlighting how the presence of a cost channel of monetary policy can offer new insights into the behavior of inflation when the Phillips curve is locally quite flat. For instance, we highlight a key condition whereby lax monetary policy can push the economy in a low inflation trap and we discuss how, under the same condition, standard policy rules for targeting inflation may need to be modified. In the second part of the paper we explore the empirical relevance of the conditions that give rise to these observations using US data. To this end, we present both (i) a wide set of estimates derived from single-equation estimation of the Phillips curve and (ii) estimates based on structural estimation of a full model. The results from both sets of empirical exercises strongly support the key condition we derived.
Keywords: Monetary Policy; Inflation; Interest Rates
JEL Codes: E3; E32; E24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Patman condition holds (C62) | marginal increase in real interest rates leads to increase in inflation (E31) |
| restrictive monetary policy (E52) | inflationary effects under certain conditions (E31) |
| timid response to shocks (E32) | exacerbates inflation deviations from targets (E31) |
| not responding aggressively enough to supply shocks (E19) | pushes inflation further from its target (E31) |
| small response to demand shocks (E39) | destabilizes inflation rather than stabilizes it (E31) |
| maintaining real interest rates at their long-run steady state (E43) | more effective than fine-tuning inflation (E63) |