Wealth effects, price markups, and the neo-Fisherian hypothesis

Abstract

The present paper thoroughly investigates the occurrence of positive comovement between inflation and the nominal interest rate conditional on a nominal shock — the so-called neo-Fisherian hypothesis in a New Keynesian framework. By introducing Jaimovich–Rebelo (JR) consumption–labor nonseparable preferences into an otherwise standard New Keynesian model, we show that neo-Fisherianism depends on the extent of wealth effects in households’ labor supply decisions. Neo-Fisherianism appears more prominent in economic environments with weaker wealth effects in labor supply (in particular for Greenwood–Hercowitz–Huffmann preferences where wealth effects are absent), smaller price-to-wage markups (for which the steady state is less distorted), and smaller real wage rigidity. Following a permanent interest rate shock, the neo-Fisherian hypothesis is guaranteed to hold regardless of the utility preferences or degree of real wage rigidity. A more prominent presence of endogenous capital works in favor of neo-Fisherianism. Finally, the stabilizing properties of Taylor rules under JR preferences are scrutinized.