Kiel Working Papers, Kiel Institute for World Economics
No 1349:
Inflation Persistence and the Philips Curve Revisited
Marika Karanassou and Dennis Snower
Abstract: A major criticism against staggered nominal contracts is
that they give rise to the so called "persistency puzzle" - although they
generate price inertia, they cannot account for the stylised fact of
inflation persistence. It is thus commonly asserted that, in the context of
the new Phillips curve (NPC), inflation is a jump variable. We argue that
this "persistency puzzle" is highly misleading, relying on the exogeneity
of the forcing variable (e.g. output gap, marginal costs, unemployment
rate) and the assumption of a zero discount rate. We show that when the
discount rate is positive in a general equilibrium setting (in which real
variables not only affect inflation, but are also influenced by it),
standard wage-price staggering models can generate both substantial
inflation persistence and a nonzero inflation-unemployment tradeoff in the
long-run. This is due to frictional growth, a phenomenon that captures the
interplay of nominal staggering and permanent monetary changes. We also
show that the cumulative amount of inflation undershooting is associated
with a downward-sloping NPC in the long-run.
Keywords: Inflation dynamics, persistence, wage-price staggering, new Phillips curve, monetary policy, frictional growth; (follow links to similar papers)
JEL-Codes: E31,; E32,; E42,; E63; (follow links to similar papers)
24 pages, June 2007
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