Recent empirical evidence by Fair (2002 Fair ( , 2005 and Giordani (2003) shows that a positive inflation shock with the nominal interest rate held constant has contractionary effects. These results cannot be reconciled with the standard 'New Synthesis' literature. This paper reconsiders the effects of inflation shocks in a simple New Keynesian framework extended to include wealth effects. It is shown that, following an inflation shock, the decline of output coupled with passive interest rate

more »

... les is not puzzling. We are very grateful to Jean-Pascal Bénassy for his helpful comments and suggestions on a earlier version of this paper. Thanks are also due to Andrea Costa, Jordi Galí, Nicola Giammarioli, and Giancarlo Marini for useful comments and discussions. Financial support from CNR and the FIRB project is gratefully acknowledged. The usual disclaimer applies. A detailed 1 Fair obtains his results in structural econometric models, while Giordani uses a VAR analysis.