Working Paper: NBER ID: w18007
Authors: Roger E.A. Farmer
Abstract: This paper has three parts. Part 1 constructs a classical economic model of inflation, augmented by a complete set of financial markets; I call this the core monetary model. Part 2 develops a series of calibrated examples to illustrate how the core monetary model explains the history of inflation after WWII and Part 3 provides evidence to show that the unconventional monetary policy, followed in the wake of the 2008 financial crisis, was effective in stabilizing inflation expectations. The core monetary model provides a unified framework to explain how an interest rule can be used to control inflation in normal times, and to explain the purpose of unconventional monetary policy when policy attains the zero lower bound. I argue that management of the variation in the composition of the Fed's balance sheet, is an important tool in a central bank's arsenal that can be used to help prevent deflation in the wake of a financial crisis.
Keywords: Monetary Policy; Inflation Expectations; Quantitative Easing
JEL Codes: E31; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Conventional monetary policy (E52) | Inflation rates (E31) |
| Unconventional monetary policy (E52) | Inflation expectations (E31) |
| Increase in Fed's balance sheet (E52) | Rising inflation expectations (E31) |
| Aggressive monetary policy rules (E52) | Lower and less volatile inflation (E31) |
| Unconventional monetary policy (E52) | Current prices and expectations (D84) |
| Unconventional monetary policy (E52) | Inflation rates (E31) |