Positive Trend Inflation and Determinacy in a Medium-Sized New Keynesian Model

Melbourne Institute Working Paper No. 09/18

Date: July 2018


Jonas E Arias
Guido Ascari
Nicola Branzoli
Efrem Castelnuovo


This paper studies the challenge that increasing the inflation target poses to equilibrium determinacy in a medium-sized New Keynesian model without indexation fitted to the Great Moderation era. For moderate targets of the inflation rate, such as 2 or 4 percent, the probability of determinacy is near one conditional on the monetary policy rule of the estimated model. However, this probability drops significantly conditional on model-free estimates of the monetary policy rule based on real-time data. The difference is driven by the larger response of the federal funds rate to the output gap associated with the latter estimates.

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