THE REAL-INTEREST-RATE GAP AS AN INFLATION INDICATOR

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Abstract
A long-standing area of research and policy interest is the construction of a measure of monetary policy stance. One measure that has been proposed, as an alternative to indices that employ monetary aggregates or exchange rates, is the spread between the actual real interest rate and its flexible-price, or natural-rate, counterpart. We examine the properties of the natural real interest rate and real-interest-rate gap using a dynamic stochastic general equilibrium model. Issues we investigate include the response of the gap and its components to fundamental economic shocks and the indicator and forecasting properties of the real-interest-rate gap for inflation, both in the model and in the data. Our results suggest that the real-interest-rate gap has value as an inflation indicator, supporting a neo-Wicksellian framework.

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