DP1068 Inflation, Nominal Interest Rates and the Variability of Output

Author(s): Bankim Chadha, Daniel Tsiddon
Publication Date: November 1994
Keyword(s): Inflation, Output Variability, Stickiness
JEL(s): E12, E30, E41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1068

This paper examines the distribution of output around capacity when money demand is a non-linear function of the nominal interest rate such that nominal interest rates cannot become negative. When fluctuations in output result primarily from disturbances to the money market, the variance of output is shown to be an increasing function of the trend inflation rate. When they result from disturbances to the goods market, the variance of output is a decreasing function of the trend inflation rate. When both disturbances are significant, there exists, in general, a critical non-zero trend inflation rate that minimizes the variance of output.