Do Inflation Regimes Affect the Transmission of Positive Nominal Demand Shocks to the Consumer Price Level?
Evidence reveals that real output rises much higher in the low inflation regime than in the high inflation regime. Thus, a nominal demand policy shock affecting aggregate demand will have a bigger effect on real output in the low inflation regime than in the high inflation regime. We find that inflation rises and fluctuates much higher in the high inflation regime than in the low inflation regime, following a nominal demand shock. Evidence confirms the new Keynesian hypothesis, which implies that a demand policy is less effective in countries with high trend inflation and where prices are less rigid.
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