Monetary policy inertia and the paradox of flexibility

Resolving New Keynesian Puzzles

“…The paradox of flexibility is defined in Eggertsson and Krugman (2012) and is the result that reductions in price stickiness increases the relative strength of all the other puzzles at the ZLB, i.e., in the face of current and anticipated shocks, the ZLB constraint is even more disruptive in the model as price flexibility increases. Bonciani and Oh (2023) note that a shadow rate here to can eliminate the flexibility puzzle.…”

“…For example, Hills and Nakata (2018) and Bonciani and Oh (2023) show discrepancies between shadow rates and Rule (2) can explain the fiscal forward guidance puzzle and the paradox of flexibility. 5 The puzzles will also be mitigated when closing models with policy rules that cap-ture average inflation targeting, which share features with rule (3).…”