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Modeling inflation after the crisis

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  • James H. Stock
  • Mark W. Watson

Abstract

In the United States, the rate of price inflation falls in recessions. Turning this observation into a useful inflation forecasting equation is difficult because of multiple sources of time variation in the inflation process, including changes in Fed policy and credibility. We propose a tightly parameterized model in which the deviation of inflation from a stochastic trend (which we interpret as long-term expected inflation) reacts stably to a new gap measure, which we call the unemployment recession gap. The short-term response of inflation to an increase in this gap is stable, but the long-term response depends on the resilience, or anchoring, of trend inflation. Dynamic simulations (given the path of unemployment) match the paths of inflation during post-1960 downturns, including the current one.

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Bibliographic Info

Article provided by Federal Reserve Bank of Kansas City in its journal Proceedings - Economic Policy Symposium - Jackson Hole.

Volume (Year): (2010)
Issue (Month): ()
Pages: 173-220

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Handle: RePEc:fip:fedkpr:y:2010:p:173-220

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Keywords: Financial crises ; Inflation (Finance) ; Unemployment ; Phillips curve;

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Cited by:
  1. Joseph S. Vavra, 2014. "Time-Varying Phillips Curves," NBER Working Papers 19790, National Bureau of Economic Research, Inc.
  2. Hayat, Muhammad Azmat & Farvaque, Etienne, 2012. "Public attitudes towards central bank independence: Lessons from the foundation of the ECB," European Journal of Political Economy, Elsevier, vol. 28(4), pages 512-523.
  3. Clements, Michael P. & Galvão, Ana Beatriz, 2013. "Forecasting with vector autoregressive models of data vintages: US output growth and inflation," International Journal of Forecasting, Elsevier, vol. 29(4), pages 698-714.
  4. Clements, Michael P., 2014. "Probability distributions or point predictions? Survey forecasts of US output growth and inflation," International Journal of Forecasting, Elsevier, vol. 30(1), pages 99-117.
  5. Troy Matheson & Emil Stavrev, 2013. "The Great Recession and the Inflation Puzzle," IMF Working Papers 13/124, International Monetary Fund.
  6. Joshua C C Chan, 2012. "Moving Average Stochastic Volatility Models with Application to Inflation Forecast," ANU Working Papers in Economics and Econometrics 2012-591, Australian National University, College of Business and Economics, School of Economics.
  7. Liebermann, Joelle, 2012. "Real-time forecasting in a data-rich environment," MPRA Paper 39452, University Library of Munich, Germany.
  8. Gumbau-Brisa, Fabia & Olivei, Giovanni P., 2013. "An evaluation of the Federal Reserve estimates of the natural rate of unemployment in real time," Working Papers 13-24, Federal Reserve Bank of Boston.
  9. Rochelle M. Edge & Refet S. Gurkaynak, 2011. "How useful are estimated DSGE model forecasts?," Finance and Economics Discussion Series 2011-11, Board of Governors of the Federal Reserve System (U.S.).
  10. Evan F. Koenig & Tyler Atkinson, 2012. "Inflation, slack, and Fed credibility," Staff Papers, Federal Reserve Bank of Dallas, issue Jan.
  11. Steffen Henzel & Elisabeth Wieland, 2013. "Synchronization and Changes in International Inflation Uncertainty," CESifo Working Paper Series 4194, CESifo Group Munich.
  12. Fröhling, Annette & Lommatzsch, Kirsten, 2011. "Output sensitivity of inflation in the euro area: Indirect evidence from disaggregated consumer prices," Discussion Paper Series 1: Economic Studies 2011,25, Deutsche Bundesbank, Research Centre.
  13. Jaromir Baxa & Miroslav Plasil & Borek Vasicek, 2013. "Inflation and the Steeplechase Between Economic Activity Variables," Working Papers 2013/15, Czech National Bank, Research Department.
  14. Hugo Gerard, 2012. "Co-movement in Inflation," RBA Research Discussion Papers rdp2012-01, Reserve Bank of Australia.
  15. Eva M. Köberl, 2011. "Kapazitätsauslastung, Produktionshemmnisse und Preisanpassungen unter dem Mikroskop," KOF Analysen, KOF Swiss Economic Institute, ETH Zurich, vol. 5(4), pages 43-54, December.

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