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Inflation Dynamics When Inflation Is Near Zero

  • JEFFREY C. FUHRER
  • GIOVANNI P. OLIVEI
  • GEOFFREY M. B. TOOTELL

This paper discusses the likely evolution of U.S. inflation in the near and medium term on the basis of (1) past U.S. experience with very low levels of inflation, (2) the most recent Japanese experience with deflation, and (3) recent U.S. micro evidence on downward nominal wage rigidity. Our findings question the view that stable long-run inflation expectations and downward nominal wage rigidity will provide sufficient support to prices such that deflation can be avoided. We show that an inflation model fitted on Japanese data over the past 20 years, which accounts for both short- and long-run inflation expectations, matches the recent U.S. inflation experience quite well. While the model indicates that U.S. inflation might be subject to a lower bound, it does not rule out a prolonged period of mild deflation going forward. In addition, our micro evidence on wages suggests no obvious downward rigidity in the firm's wage costs, downward rigidity in individual wages notwithstanding. As a consequence, downward nominal wage rigidity may provide little offset to deflationary pressures in the current U.S. situation, despite some circumstantial evidence that this channel might have been at work in the past.

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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2011.00479.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 44 (2012)
Issue (Month): (02)
Pages: 83-122

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i::p:83-122
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. David Card & Dean Hyslop, 1997. "Does Inflation "Grease the Wheels of the Labor Market"?," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 71-122 National Bureau of Economic Research, Inc.
  2. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
  3. Emmanuel De Veirman, 2009. "What Makes the Output-Inflation Trade-Off Change? The Absence of Accelerating Deflation in Japan," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(6), pages 1117-1140, 09.
  4. Ricardo Nunes, 2010. "Inflation Dynamics: The Role of Expectations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(6), pages 1161-1172, 09.
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