Macro

• Nominal and real wage growth, St. Louis Fed, 2012-2023.

A Model of Inflation and Interest Rates

 John Cochrane has a good Substack on how hard it is to build a model in which a rise in nominal interest rates by the Fed will generate lower inflation. He begins by rejecting the monetarist model, because the Fed doesn't control the money supply any more. It is endogenous. Money-- via credit cards, etc.-- will expand as money demand asks. 

Here is my attempt. Start with inflation equalling inflation last period plus something if output is above normal. The rationale is that agents have to coordinate on some price rise, since the price level is arbitrary, so they coordinate on last period's inflation. It is costless for everbody to raise prices that much, because it requires no thinking, just coordination. We will have to get later to why above-normal output raises inflation.

The nominal interest rate is the real interest rate plus expected inflation. Also, it can be manipulated by the Fed. Let's suppose the real rate is 3% and expected inflation is 5% in steady state, so the nominal interest rate is 8%.

Now suppose the nominal interest rate rises. That could be because the real interest rate has risen, or expected inflation has risen, or the Fed did some manipulation. It isn't expected inflation rising that starts this off, though, because expected inflation is endogenous--- it is last period's inflation plus the real-output effect.