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Modelling Inflation Dynamics: A Critical Review of Recent Research

Listed author(s):
  • Rudd, Jeremy

    (Federal Reserve Board)

  • Whelan, Karl

    (Central Bank and Financial Services Authority of Ireland)

In recent years, a broad academic consensus has arisen around the use of rational expectations sticky-price models to capture inflation dynamics. These models are seen as providing an empirically reasonable characterization of observed inflation behavior once suitable measures of the output gap are chosen; and, moreover, are perceived to be robust to the Lucas critique in a way that earlier econometric models of inflation are not. We review the principal conclusions of this literature concerning: 1) the ability of these models to fit the data; 2) the importance of rational forward-looking expectations in price setting; and 3) the appropriate measure of inflationary pressures. We argue that existing rational expectations sticky-price models fail to provide a useful empirical description of the inflation process, especially relative to traditional econometric Phillips curves of the sort commonly employed for policy analysis.

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Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 7/RT/05.

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Length: 53 pages
Date of creation: Nov 2005
Handle: RePEc:cbi:wpaper:7/rt/05
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