POSITIVE TREND INFLATION AND DETERMINACY IN A MEDIUM-SIZED NEW KEYNESIAN MODEL

Arias, Jonas E.; Ascari, Guido; Branzoli, Nicola; Castelnuovo, Efrem

Working Paper

POSITIVE TREND INFLATION AND DETERMINACY IN A MEDIUM-SIZED NEW KEYNESIAN MODEL

Abstract: This paper studies the challenge that increasing the inflation target poses to equilibrium determinacy in a medium-sized New Keynesian model without indexation fitted to the Great Moderation era. For moderate targets of the inflation rate, such as 2 or 4 percent, the probability of determinacy is near one conditional on the monetary policy rule of the estimated model. However, this probability drops significantly conditional on model-free estimates of the monetary policy rule based on real-time data. The difference is driven by the larger response of the federal funds rate to the output gap associated with the latter estimates.

Keywords: trend inflation; determinacy; monetary policy;

JEL Classification: C22; E3; E52;