Kiel Working Papers, Kiel Institute for World Economics
No 1365:
Learning, Sticky Inflation, and the Sacrifice Ratio
John M. Roberts
Abstract: Over the past forty years, U.S. inflation has exhibited
highly persistent movements. Moreover, these shifts in inflation have
typically had real consequences, implying a "sacrifice ratio," whereby
disinflations are typically associated with recessions and persistent
increases in inflation often associated with booms. One hypothesis about
the source of the sacrifice ratio is that inflation - and not just the
price level - is sticky. Another is that private-sector agents typically
must infer changes in inflation objectives indirectly from central bank
interest- rate policy. The resulting learning process can lead to a
sacrifice ratio trade-off. In this paper, I allow for both sticky inflation
and learning in interpreting U.S. macroeconomic developments since 1955.
Two key empirical findings are, first, that allowing for learning reduces
the evidence for sticky inflation. Second, there is less evidence for
sticky inflation in the post-1983 period than earlier. Indeed, in some
estimates, there is little evidence of sticky inflation in the period since
1983, although this result is sensitive to the details of the
specification. Nonetheless, simulation results suggest that for realistic
models, the sacrifice ratio can be accounted for entirely by learning.
35 pages, June 2007
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