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Regime Changes and Monetary Stagflation By Edward S. Knotek II |
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Abstract This paper examines whether monetary shocks can consistently generate
stagflation in a dynamic, stochastic setting. I assume that the monetary
authority can induce transitory shocks and longer-lasting monetary regime
changes in its operating instrument. Firms cannot distinguish between these
shocks and must learn about them using a signal extraction problem. The
possibility of changes in the monetary regime greatly improves the ability
of money to generate stagflation. This is true whether the regime actually
changes or not. If the monetary regime changes on average once every ten
years, stagflation occurs in 76% of model simulations. The intuition for
this result is simple: increased output volatility due to learning coupled
with inflation inertia produce conditions conducive to the emergence of
stagflation. The incidence of stagflation can be reduced by a stable,
transparent central bank. Keywords: Stagflation, monetary regime changes, signal extraction, sticky
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