From Price Puzzle to Neo-Fisherianism

Abstract

Neo-Fisher effect states that an increase in nominal rate of interest which deemed to be permanent, will lead to a rise in inflation both in the short-run as well as in the long-run. In this paper, we study the possibility of occurrence of neo-Fisher effect in a new-Keynesian model. For this purpose, we develop a closed economy new-Keynesian model which account for cost channel of monetary policy, consumption persistence in agents’ utility function, and real wage rigidity. Our analytical results reveal that in the presence of cost channel of monetary policy, neo-Fisher effect occur even when the monetary innovation shock is purely stochastic. In our calibration exercises we show that the inclusion of habit persistence in consumption and real wage rigidities in the model help in eliminating the neo-Fisher effect despite the presence of cost channel of monetary policy and the persistence in the monetary innovation shock. We also found that in case of permanent monetary innovation shock, we cannot break the neo-Fisher effect.