Inflationary Permanent and Long-Term Positive Interest Rate Shocks

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Ahmadian, Mohammad Hesam | 2023

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Type of Document: M.Sc. Thesis
Language: English
Document No: 56726 (44)
University: Sharif University of Technology
Department: Management and Economics
Advisor(s): Rahmati, Mohammad Hossein
Abstract:
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 that the real interest rate channel cannot explain the responses to the long-term positive interest rate shock. The only variable capable of explaining responses to both permanent and long-term shocks is the (real) loan-deposit rate spread. Increase in (real) loan-deposit rate spread decreases all economic activity and inflation, and vice versa
Keywords:
Inflation ; Monetary Policy ; Determinacy ; Real Interest Rate ; Interest Rate Spread ; Monetary Policy Shock