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Inflation in the Great Recession and New Keynesian models

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Author Info

  • Marco Del Negro
  • Marc P. Giannoni
  • Frank Schorfheide

Abstract

It has been argued that existing DSGE models cannot properly account for the evolution of key macroeconomic variables during and following the recent Great Recession, and that models in which inflation depends on economic slack cannot explain the recent muted behavior of inflation, given the sharp drop in output that occurred in 2008-09. In this paper, we use a standard DSGE model available prior to the recent crisis and estimated with data up to the third quarter of 2008 to explain the behavior of key macroeconomic variables since the crisis. We show that as soon as the financial stress jumped in the fourth quarter of 2008, the model successfully predicts a sharp contraction in economic activity along with a modest and more protracted decline in inflation. The model does so even though inflation remains very dependent on the evolution of both economic activity and monetary policy. We conclude that while the model considered does not capture all short-term fluctuations in key macroeconomic variables, it has proven surprisingly accurate during the recent crisis and the subsequent recovery.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 618.

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Date of creation: 2013
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Handle: RePEc:fip:fednsr:618

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Related research

Keywords: Inflation (Finance) ; Recessions ; Keynesian economics ; Stochastic analysis ; Equilibrium (Economics) ; Econometric models;

This paper has been announced in the following NEP Reports:

References

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  1. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2004. "The Great Depression and the Friedman-Schwartz Hypothesis," NBER Working Papers 10255, National Bureau of Economic Research, Inc.
  2. De Graeve, Ferre, 2008. "The external finance premium and the macroeconomy: US post-WWII evidence," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3415-3440, November.
  3. Clark, Todd E., 2011. "Real-Time Density Forecasts From Bayesian Vector Autoregressions With Stochastic Volatility," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(3), pages 327-341.
  4. Sandeep Mazumder & Laurence M. Ball, 2011. "Inflation Dynamics and the Great Recession," IMF Working Papers 11/121, International Monetary Fund.
  5. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  6. Sims, Christopher A, 2002. "Solving Linear Rational Expectations Models," Computational Economics, Society for Computational Economics, vol. 20(1-2), pages 1-20, October.
  7. Robert E. Hall, 2011. "The Long Slump," American Economic Review, American Economic Association, vol. 101(2), pages 431-69, April.
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Cited by:
  1. Michael T. Belongia & Peter N. Ireland, 2013. "Instability: Monetary and Real," Boston College Working Papers in Economics 830, Boston College Department of Economics.

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