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Inflation Persistence and Flexible Prices

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  • Robert Dittmar
  • William Gavin
  • Finn Kydland

Abstract

If the central bank follows an interest rate rule, then inflation is likely to be persistent, even when prices are fully flexible. Any shock, whether persistent or not, may lead to inflation persistence. In equilibrium, the dynamics of inflation are determined by the evolution of the spread between the real interest rate and the central bank's target. Inflation persistence can be characterized by a vector autocorrelation function relating inflation and output. This article shows that a flexible-price, general-equilibrium business cycle model with money and a central bank using an interest rate target can account for such inflation persistence. Copyright 2005 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2002 with number 190.

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Date of creation: 01 Jul 2002
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Handle: RePEc:sce:scecf2:190

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Keywords: Inflation Persistence; Taylor Rule; Flexible Prices;

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  1. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  2. Runkle, David E, 1987. "Vector Autoregressions and Reality," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(4), pages 437-42, October.
  3. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  5. David E. Runkle, 1987. "Vector autoregressions and reality," Staff Report 107, Federal Reserve Bank of Minneapolis.
  6. Casey B. Mulligan & Xavier X. Sala-i-Martin, 1997. "The Optimum Quantity of Money: Theory and Evidence," NBER Working Papers 5954, National Bureau of Economic Research, Inc.
  7. Gary D. Hansen & Edward C. Prescott, 1992. "Recursive methods for computing equilibria of business cycle models," Discussion Paper / Institute for Empirical Macroeconomics 36, Federal Reserve Bank of Minneapolis.
  8. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
  9. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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