European Business Schools Librarian's Group
Department of Economics Working Papers,
Vienna University of Economics and Business, Department of Economics
No 350: From Linear to Nonlinear: Rethinking Inflation Dynamics in the Calvo Pricing Mechanism
Ales Marsal, Katrin Rabitsch () and Lorant Kaszab ()
Additional contact information
Ales Marsal: National Bank of Slovakia
Katrin Rabitsch: Department of Economics, Vienna University of Economics and Business
Lorant Kaszab: Magyar Nemzeti Bank
Abstract: Modern macroeconomics is increasingly leaning towards nonlinear solution methods. Our paper addresses the importance of nonlinearities in price setting. We demonstrate how nonlinearity in endogenous price adjustments, due to misalignments in relative prices, can trigger a price dispersion inflation spiral. This phenomenon yields globally unstable dynamics, even in instances where the model is locally stable around the non-stochastic steady state. We introduce the concept of the stability region as a nonlinear counterpart to the determinacy region. Our findings indicate that in a nonlinear world, the Taylor principle alone does not guarantee inflation stability and stable macroeconomic model moments. This new understanding not only challenges the conventional wisdom on inflation stabilization but also underscores the urgency for recalibrating monetary policy strategies in response to these dynamics.
Keywords: Determinacy, stability, price dispersion, monetary policy, nonlinear solution methods, macro-finance
JEL-codes: E13; E31; E43; E44 September 2023
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