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Interest Rate Rigidity and the Fisher Equation

Belanger, Gilles (2014): Interest Rate Rigidity and the Fisher Equation.

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Abstract

I create a model where private banks face adjustment costs in nominal interest rates. The model's inflation responds to interest rate changes (both nominal and real) by moving in the opposite direction. That response justifies the Taylor rule and explains, through credit conditions, the procyclicality of inflation. The model permits the analysis of different types of monetary policy using a variable inflation target. I use this feature to simulate different policies and compare them to interest rate data from the last century. The interest rate rigidity model leads to credit-conditions-driven inflation, which I believe is more realistic than competing models of inflation.

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