Journal Article

The effect of conventional and unconventional monetary policy rules on inflation expectations: theory and evidence

Roger E. A. Farmer

in Oxford Review of Economic Policy

Published on behalf of The Oxford Review of Economic Policy Ltd

Volume 28, issue 4, pages 622-639
Published in print January 2012 | ISSN: 0266-903X
Published online December 2012 | e-ISSN: 1460-2121 | DOI: http://dx.doi.org/10.1093/oxrep/grs024
The effect of conventional and unconventional monetary policy rules on inflation expectations: theory and evidence

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This paper has three parts. Part 1 constructs a classical economic model of inflation, augmented by a complete set of financial markets; I call this the core monetary model. Part 2 develops a series of calibrated examples to illustrate how the core monetary model explains the history of inflation after the Second World War, and Part 3 provides evidence to show that the unconventional monetary policy, followed in the wake of the 2008 financial crisis, was effective in stabilizing inflation expectations. The core monetary model provides a unified framework to explain how an interest rule can be used to control inflation in normal times, and to explain the purpose of unconventional monetary policy when policy attains the zero lower bound. I argue that management of the variation in the composition of the Fed’s balance sheet, is an important tool in a central bank’s arsenal that can be used to help prevent deflation in the wake of a financial crisis.

Keywords: unconventional monetary policy; central bank balance sheet; monetary policy rules; E43; E50; E52

Journal Article.  8072 words.  Illustrated.

Subjects: Monetary Policy, Central Banking, and the Supply of Money and Credit ; Money and Interest Rates

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