IDEAS home Printed from https://ideas.repec.org/a/bla/ecorec/v101y2025i332p3-40.html
   My bibliography  Save this article

Changes in the Inflation Target and the Comovement Between Inflation and the Nominal Interest Rate

Author

Listed:
  • Yunjong Eo
  • Denny Lie

Abstract

Would raising the inflation target require an increase in the nominal interest rate in the short run? We answer this policy question, first analytically in a small‐scale New Keynesian model with backward‐looking components where a closed‐form solution exists, and then, in a medium‐scale Smets and Wouters model calibrated to the US economy. Our analysis shows that the short‐run comovement between inflation and the nominal interest rate conditional on changes in the inflation target is more likely to be positive, all else equal, as the monetary authority reacts less aggressively to the deviation of inflation from its target. Meanwhile, features of the model that enhance backward‐looking behaviour, such as backward price indexation and habit formation in consumption, are shown to reduce the likelihood of the positive comovement. However, our investigations reveal that in both models, this positive comovement or the so‐called Neo‐Fisherism is prevalent across a wide range of empirically plausible parameter values. Using the Smets and Wouters model with a zero lower bound (ZLB) constraint on the nominal interest rate, we show that raising the inflation target could be an effective alternative policy framework to reduce the possibility of a binding ZLB constraint and to mitigate the potentially large output loss.

Suggested Citation

  • Yunjong Eo & Denny Lie, 2025. "Changes in the Inflation Target and the Comovement Between Inflation and the Nominal Interest Rate," The Economic Record, The Economic Society of Australia, vol. 101(332), pages 3-40, March.
  • Handle: RePEc:bla:ecorec:v:101:y:2025:i:332:p:3-40
    DOI: 10.1111/1475-4932.12853
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/1475-4932.12853
    Download Restriction: no

    File URL: https://libkey.io/10.1111/1475-4932.12853?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:ecorec:v:101:y:2025:i:332:p:3-40. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/esausea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.