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The macroeconomics of trend inflation

  • Ascari, Guido

    (University of Oxford and University of Pavia)

  • Sbordone, Argia M.

    (Federal Reserve Bank of New York)

Most macroeconomic models for monetary policy analysis are approximated around a zero inflation steady state, but most central banks target an inflation rate of about 2 percent. Many economists have recently proposed even higher inflation targets to reduce the incidence of the zero lower bound constraint on monetary policy. In this survey, we show that the conduct of monetary policy should be analyzed by appropriately accounting for the positive trend inflation targeted by policymakers. We first review empirical research on the evolution and dynamics of U.S. trend inflation and some proposed new measures to assess the volatility and persistence of trend-based inflation gaps. We then construct a Generalized New Keynesian model that accounts for a positive trend inflation. In this model an increase in trend inflation is associated with a more volatile and unstable economy and tends to destabilize inflation expectations. This analysis offers a note of caution regarding recent proposals to address the existing zero lower bound problem by raising the long-run inflation target.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 628.

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Length: 67 pages
Date of creation: 2013
Date of revision: 01 May 2014
Handle: RePEc:fip:fednsr:628
Note: For a published version of this report, see Guido Ascari and Argia M. Sbordone, "The Macroeconomics of Trend Inflation," Journal of Economic Literature 52, no. 3 (September 2014): 679-739.
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