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Inflation Persistence and the Philips Curve Revisited

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  • Marika Karanassou
  • Dennis Snower

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 Kiel Institute for the World Economy in its series Kiel Working Papers with number 1349.

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Length: 24 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:kie:kieliw:1349

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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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  1. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, American Economic Association, vol. 69(2), pages 108-13, May.
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Citations

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Cited by:
  1. Marika Karanassou & Hector Sala, 2008. "Productivity Growth and the Phillips Curve: A Reassessment of the US Experience," Discussion Papers, School of Economics, The University of New South Wales 2008-06, School of Economics, The University of New South Wales.
  2. Agénor, Pierre-Richard & Bayraktar, Nihal, 2010. "Contracting models of the Phillips curve empirical estimates for middle-income countries," Journal of Macroeconomics, Elsevier, Elsevier, vol. 32(2), pages 555-570, June.
  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. Adolfo Sachsida & Marcio Ribeiro & Claudio Hamilton dos Santos, 2009. "A Curva de Phillips e a Experiência Brasileira," Discussion Papers, Instituto de Pesquisa Econômica Aplicada - IPEA 1430, Instituto de Pesquisa Econômica Aplicada - IPEA.
  5. Samuel Bentolila & Juan Jose Dolado & Juan F. Jimeno, 2007. "Does Immigration Affect the Phillips Curve? Some Evidence for Spain," CESifo Working Paper Series 2166, CESifo Group Munich.
  6. Knell, Markus & Stiglbauer, Alfred, 2009. "The impact of reference norms on inflation persistence when wages are staggered," Working Paper Series, European Central Bank 1047, European Central Bank.
  7. Andrew Phiri, 2012. "Threshold effects and inflation persistence in South Africa," Journal of Financial Economic Policy, Emerald Group Publishing, Emerald Group Publishing, vol. 4(3), pages 247-269, August.

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