A Theory of Intrinsic Inflation Persistence

Abstract

We propose a novel theory of intrinsic inflation persistence by introducing trend inflation and variable elasticity of demand in a model with staggered price and wage setting. Under nonzero trend inflation, the variable elasticity generates intrinsic persistence in inflation through a measure of price dispersion stemming from staggered price setting. It also introduces intrinsic persistence in wage inflation under staggered wage setting, which affects price inflation. With the theory we show that inflation exhibits a persistent, hump-shaped response to a monetary policy shock. We also show that a credible disinflation leads to a gradual decline in inflation and a fall in output, and lower trend inflation reduces inflation persistence, as observed around the time of the Volcker disinflation.

Output-inflation trade-offs and the optimal inflation rate

“…14 Using the law of motion (26) to substitute for the current, past, and expected future real marginal costs of aggregating goods-d t , d t−1 , E t d t+1 -in ( 22) introduces lags of inflation in the NKPC. Therefore, the model provides a theoretical justification for intrinsic inertia in inflation without relying on ad hoc backward-looking price-setting behavior (e.g., price indexation), as pointed out by Kurozumi and Van Zandweghe (2019).…”

Inflation in the G7 Countries: Persistence and Structural Breaks

“…More recently, Kurozumi and Van Zandweghe (2019) (1, 1) models for the individual countries does not indicate any significant differences between developing and developed countries in the behaviour of the conditional volatility of inflation; however, GMM panel estimation suggests that inflation is nearly three and half times more volatile in developing countries compared to developed countries.…”

Inflation Gap Persistence, Indeterminacy, and Monetary Policy

“…Recent research considers the implications of such a higher inflation target for welfare (Ascari et al (2018)), equilibrium determinacy (Khan et al (2020)), and inflation (gap) persistence (Kurozumi and Van Zandweghe (2019)). Because our model relates inflation dynamics to the steady-state inflation rate, it can provide another perspective on the debate about raising the inflation target.…”