The Real Interest Rate Gap as an Inflation Indicator

53 Pages Posted: 26 Jun 2001

See all articles by Katharine S. Neiss

Katharine S. Neiss

Bank of England - Monetary Analysis

Edward Nelson

Board of Governors of the Federal Reserve System

Date Written: June 2001

Abstract

A long-standing area of research and policy interest has been the construction of a measure of monetary policy stance. One measure that has been proposed?as an alternative to indices that employ monetary aggregates or exchange rates?is the spread between the actual real interest rate and its flexible-price, or natural-rate, counterpart. We examine the properties of the natural real interest rate and 'real interest rate gap' using a dynamic stochastic general equilibrium model. Issues we investigate include: (1) the response of the gap and its components to fundamental economic shocks; and (2) the indicator and forecasting properties of the real interest rate gap for inflation, both in the model and in the data. Our results suggest that the real interest rate gap has value as an inflation indicator, supporting the 'neo-Wicksellian framework' advocated by Woodford (2000).

Keywords: Natural interest rate, monetary policy, inflation, output gap, real interest rate gap

JEL Classification: E31, E43, E52

Suggested Citation

Neiss, Katharine S. and Nelson, Edward, The Real Interest Rate Gap as an Inflation Indicator (June 2001). Available at SSRN: https://ssrn.com/abstract=275026

Katharine S. Neiss (Contact Author)

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom
+44 20 7601 4588 (Phone)
+44 20 7601 5018 (Fax)

Edward Nelson

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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