Understanding the price puzzle

The positive relationship between the federal funds rate and inflation has become known as the price puzzle, so called because an unexpected tightening of monetary policy is expected to be followed by a decrease in the price level, rather than an increase. The positive correlation between federal fu...

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Bibliographic Details
Published in:Economic review (Dallas, Tex.) Tex.), 1994-10, p.15
Main Authors: Balke, Nathan S, Emery, Kenneth M
Format: Article
Language:English
Subjects:
Bond markets
Economic theory
Economists
Federal funding
Federal funds rate
Federal Reserve monetary policy
GDP
Gross Domestic Product
Inflation
Monetary policy
Price level changes
Price levels
Prices
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Summary:The positive relationship between the federal funds rate and inflation has become known as the price puzzle, so called because an unexpected tightening of monetary policy is expected to be followed by a decrease in the price level, rather than an increase. The positive correlation between federal funds rate increases and subsequent increases in prices is documented, and possible explanations for the price puzzle are evaluated. The first is that the Federal Reserve systematically responds to expectations of higher future inflation by increasing the funds rate but not by enough to actually prevent inflation from rising. A 2nd explanation is that the Federal Reserve systematically reacts to negative inflationary supply shocks by appropriately increasing the funds rate but again not by enough to extinguish the inflationary consequences of the shock.
ISSN:0732-1414
2163-5838