Drifting inflation targets and monetary stagflation

Abstract

a b s t r a c tThis paper revisits the phenomenon of stagflation. Using a standard New Keynesian dynamic, stochastic general equilibrium model, we show that stagflation from monetary policy alone is a very common occurrence when the economy is subject to both deviations from the policy rule and a drifting inflation target. Once the inflation target is fixed, the incidence of stagflation in the baseline model is essentially eliminated. In contrast with several other recent papers that have focused on the connection between monetary policy and stagflation, we show that while high uncertainty about monetary policy actions can be conducive to the occurrence of stagflation, imperfect information more generally is not a requisite channel to generate stagflation.

Wealth Effects, Price Markups, and the Neo-Fisherian Hypothesis

“…The positive comovement between short-term nominal rates and inflation, in response to a shock to the inflation target, has been found in other insightful works. For instance, Khan and Knotek (2015) find that in a standard New Keynesian model with separable utility preferences that embed habit in consumption and money balances, both inflation and nominal rates fall, following a negative inflation target shock. This result is robust to whether the private sector has full knowledge about the inflation target or is learning about it.…”