The Dynamic Effects of Disinflation Policies

Abstract

This paper investigates the effects of disinflation policies on key macroeconomic variables. Using postwar US data and episode techniques, we identify disinflation shock as shocks that drive the inflation rate to a lower level in the long-run. We find that in the immediate aftermath of a disinflation policy, the economy enters in a persistent recession. The inflation rate increases above its long-run level and exhibits a positive hump-shaped response. A similar pattern is found for the nominal interest rate, which responds even more strongly in the short-run. We then show that the standard new Keynesian model fails to account for macroeconomic dynamics in disinflationary times. On the contrary a deep habit version of the model successfully accounts for the effects of disinflation policies.

Raising an Inflation Target: The Japanese Experience with Abenomics

“…The investment adjustment cost parameter is set at ϕ = 10 and the curvature parameter in the utilization function is ζ = 0.75. The autocorrelation of the consumption preference shock is 0.9.12 Incidentally, we note that increases in the inflation target do not necessarily lead to a short-run boost in output in purely forward-looking new-Keynesian models with Calvo-style nominal rigidities (see for instanceAscari and Ropele 2012, Collard, Fve, and Matheron 2007, and Mankiw and Reis 2002. The forward-looking dynamics of the price setting mechanism imply that inflation behaves like a "jump variable": although some individual prices are sticky, the aggregate inflation rate may still change a lot because of the forward-looking actions of those who can change prices.…”

Raising an inflation target: The Japanese experience with Abenomics

“…12 Incidentally, we note that increases in the inflation target do not necessarily lead to a short-run boost in output in purely forward-looking new-Keynesian models with Calvo-style nominal rigidities (see for instance Ascari and Ropele 2012, Collard, Fve, and Matheron 2007, and Mankiw and Reis 2002. The forward-looking dynamics of the price setting mechanism imply that inflation behaves like a "jump variable": although some individual prices are sticky, the aggregate inflation rate may still change a lot because of the forward-looking actions of those who can change prices.…”

Can Cold Turkey Reduce Inflation Inertia? Evidence on Disinflation and Level‐k Thinking from a Laboratory Experiment

“…It is well known that the standard New Keynesian model does a poor job in explaining inflation inertia (Buiter and Grafe 2001, Mankiw 2001, Fuhrer 2009. Several modifications to models with rational expectations have been proposed such as mechanical indexation (Yun 1996, Christiano, Eichenbaum, and Evans 2005, Ascari and Ropele 2012, real wage rigidities (Blanchard andGalí 2007, Ascari andMerkl 2009), staggered pricing policies (Calvo, Celasun, and Kumhof 2007), sticky information (Mankiw and Reis 2002, Agliari et al 2017, Branch and Evans 2017, rational inattention (Zhang 2017), or habits (Collard, Fève, and Matheron 2007). But, as argued by Nimark (2008), these emerge as ad-hoc fixes, aimed at identifying features that might align theory with evidence rather than pushing toward a more general theory.…”