A Theory of Intrinsic Inflation Persistence
March 13, 2023
Willem Van Zandweghe*2
We propose a novel theory of intrinsic inflation persistence by introducing trend inflation and Kimball (1995)-type aggregators of individual differentiated goods and labor in a model with staggered price- and wage-setting. Under nonzero trend inflation, the non-CES aggregator of goods and staggered price-setting give rise to a variable real marginal cost of goods aggregation, which becomes a driver of inflation. This marginal cost consists of an aggregate of the goods' relative prices, which depends on past inflation, thereby generating intrinsic inertia in inflation. Likewise, the non-CES aggregator of labor and staggered wage-setting lead to intrinsic inertia in wage inflation, which enhances the persistence of price inflation. With the theory we show that inflation exhibits a persistent, hump-shaped response to monetary policy shocks. We also demonstrate that lower trend inflation reduces inflation persistence and that a credible disinflation leads to a gradual decline in inflation and a fall in output.
Trend inflation, Non-CES aggregator, Credible disinflation
The authors are grateful to Argia Sbordone (discussant), Marco Bassetto, Susanto Basu, Toni Braun, Brent Bundick, Olivier Coibion, Ferre De Graeve, Michael Dotsey, Andrew Foerster, Jeffrey Fuhrer, Mark Gertler, Kinda Hachem, Narayana Kocherlakota, Pok-sang Lam, Michal Marencak, Kiminori Matsuyama, Emi Nakamura, Roberto Pinheiro, Juan Rubio-Ramírez, Slavik Sheremirov, Lee Smith, Joe Vavra, Raf Wouters, and participants at 2017 NASMES, 2017 SNDE, Spring 2017 MMM, 2015 Federal Reserve System Meeting on Macroeconomics, SWET 2017, 2019 CEF, 6th CIGS End of Year Macroeconomics Conference, 2020 Econometric Society World Congress, and seminars at the Federal Reserve Banks of Boston, Cleveland, and Kansas City, the Federal Reserve Board, the National Bank of Belgium, and the University of Kansas for comments and discussions. Martin DeLuca provided excellent research assistance. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of Japan, the Federal Reserve Bank of Cleveland, or the Federal Reserve System.
- *1Monetary Affairs Department, Bank of Japan
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- *2Research Department, Federal Reserve Bank of Cleveland
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