Working Paper: NBER ID: w23977
Authors: Martn Uribe
Abstract: I investigate the effects of an increase in the nominal interest rate on inflation and output in the United States and Japan during the postwar period. I postulate a structural autoregressive model that allows for transitory and permanent nominal and real shocks. I find that nominal interest-rate increases that are expected to be temporary, lead, in accordance with conventional wisdom, to a temporary increase in real rates that is contractionary and deflationary. By contrast, nominal interest-rate increases that are perceived to be permanent cause a temporary decline in real rates with inflation adjusting faster than the nominal interest rate to a higher permanent level. Estimated impulse responses show that inflation reaches its long-run level within a year. Importantly, because real rates are low during the transition, the economy does not suffer an output loss. This result is relevant for the design of monetary policy in economies plagued by chronic below-target inflation, for it is consistent with the prediction that a credible announcement of a gradual return of nominal rates to normal levels can bring about a swift convergence of inflation to its target level without negative consequences for aggregate activity.
Keywords: Neo-Fisher Effect; Nominal Interest Rate; Inflation; Output
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| temporary increases in nominal interest rates (E43) | temporary increase in real rates (E43) |
| temporary increases in nominal interest rates (E43) | decrease in aggregate demand (E00) |
| temporary increases in nominal interest rates (E43) | decrease in inflation (E31) |
| permanent increases in nominal interest rates (E43) | temporary decline in real rates (E43) |
| permanent increases in nominal interest rates (E43) | rapid adjustment of inflation (E31) |
| permanent increases in nominal interest rates (E43) | swift convergence of inflation to a higher permanent level (E31) |
| credible announcement of gradual return to normal nominal rates (E43) | convergence of inflation to target levels (E31) |
| permanent increases in nominal interest rates (E43) | low real rates during transition (E43) |
| permanent increases in nominal interest rates (E43) | no output loss (Y70) |