This paper examines whether monetary shocks can consistently generate stagflation in a dynamic, stochastic setting. I assume that the monetary authority can induce transitory shocks and longer-lasting monetary regime changes in its operating instrument. Firms cannot distinguish between these shocks and must learn about them using a signal extraction problem. The possibility of changes in the monetary regime greatly improves the ability of money to generate stagflation. This is true whether the regime actually changes or not. If the monetary regime changes on average once every ten years, stagflation occurs in 76% of model simulations. The intuition for this result is simple: increased output volatility due to learning coupled with inflation inertia produce conditions conducive to the emergence of stagflation. The incidence of stagflation can be reduced by a stable, transparent central bank.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number
RWP 06-05.