Wednesday, September 28, 2016
Farmer expositing the stationary assumption in NK models
The thought experiment is this: Suppose there was no government debt, and the Fed raised nominal interest rates to 20% and held them there forever. What would happen to real rates? Well, they wouldn't rise to 20% forever, because there's just no way that our society can physically, technologically deliver a 20% riskless rate of return to bondholders. Eventually, one of two things would have to happen: either 1) the Fed's control over the nominal interest rate would break down, or 2) inflation would rise (the Neo-Fisherite result). If the Fed can't control the nominal interest rate, then our standard models of monetary policy all break down, and we have to think about the microeconomics of money demand, which is hard to do. But the only alternative would be the Neo-Fisherite result.
Posted by Owen Paine at 11:24 AM