Positive Trend Inflation and Determinacy in a Medium-Sized New Keynesian Model
Melbourne Institute Working Paper No. 09/18
Date: July 2018
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.