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Inflation Persistence and the Phillips Curve Revisited

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Author Info

  • Karanassou, Marika

    ()
    (Queen Mary, University of London)

  • Snower, Dennis J.

    ()
    (Kiel Institute for the World Economy)

Abstract

A major criticism against staggered nominal contracts is that they give rise to the so called "persistency puzzle" – although they generate price inertia, they cannot account for the stylised fact of inflation persistence. It is thus commonly asserted that, in the context of the new Phillips curve (NPC), inflation is a jump variable. We argue that this "persistency puzzle" is highly misleading, relying on the exogeneity of the forcing variable (e.g. output gap, marginal costs, unemployment rate) and the assumption of a zero discount rate. We show that when the discount rate is positive in a general equilibrium setting (in which real variables not only affect inflation, but are also influenced by it), standard wage-price staggering models can generate both substantial inflation persistence and a nonzero inflation-unemployment tradeoff in the long-run. This is due to frictional growth, a phenomenon that captures the interplay of nominal staggering and permanent monetary changes. We also show that the cumulative amount of inflation undershooting is associated with a downward-sloping NPC in the long-run.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2600.

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Length: 26 pages
Date of creation: Feb 2007
Date of revision:
Handle: RePEc:iza:izadps:dp2600

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Keywords: inflation dynamics; persistence; wage-price staggering; new Phillips curve; monetary policy; frictional growth;

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References

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Citations

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Cited by:
  1. Samuel Bentolila & Juan J. Dolado & Juan F. Jimeno, 2007. "Does Immigration Affect The Phillips Curve? Some Evidence For Spain," Working Papers wp2007_0718, CEMFI.
  2. Knell, Markus & Stiglbauer, Alfred, 2009. "The impact of reference norms on inflation persistence when wages are staggered," Working Paper Series 1047, European Central Bank.
  3. Karanassou, Marika & Sala, Hector & Snower, Dennis J., 2007. "The Evolution of Inflation and Unemployment: Explaining the Roaring Nineties," IZA Discussion Papers 2900, Institute for the Study of Labor (IZA).
  4. Marika Karanassou & Hector Sala, 2008. "Productivity Growth and the Phillips Curve: A Reassessment of the US Experience," Working Papers 623, Queen Mary, University of London, School of Economics and Finance.
  5. Adolfo Sachsida & Marcio Ribeiro & Claudio Hamilton dos Santos, 2009. "A Curva de Phillips e a Experiência Brasileira," Discussion Papers 1429, Instituto de Pesquisa Econômica Aplicada - IPEA.
  6. Andrew Phiri, 2012. "Threshold effects and inflation persistence in South Africa," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 4(3), pages 247-269, August.

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