Sharif Digital Repository

Co-movement between inflation and nominal interest in response to an interest rate shock, dubbed neo-fisherianism, has been the subject of contentious debate since the advent of non-inflationary ZLB environment. We design an economic model rich with banking features to understand the economic responses to permanent and long-term interest rate shocks. We find that responses to a permanent positive interest rate shock depend on the monetary authorities’ speculation of the new long-term inflation rate, with the most probable outcome being a permanent increase in inflation. Responses to a long-term positive interest rate shock depict an increase and then decrease in inflation. We also discover...