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The Macroeconomics of Trend Inflation

  • Guido Ascari

    ()

    (University of Oxford and University of Pavia)

  • Argia M. Sbordone

    (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 inflation at a 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 the importance of appropriately accounting for a low, positive trend inflation rate for the conduct of monetary policy. We first review empirical research on the evolution and dynamics of US trend inflation, and some proposed new measures to assess the volatility and persistence of trend-based inflation gaps. Then we construct a Generalized New Keynesian model (GNK) which accounts for a positive trend inflation rate and we show that in this model higher trend inflation is associated with a more volatile and unstable economy and tends to destabilize inflation expectations. This analysis offers a note of caution in evaluating recent proposals of addressing the existing ZLB situation by raising the underlying rate of inflation.

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Paper provided by University of Pavia, Department of Economics and Management in its series DEM Working Papers Series with number 053.

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Length: 62 pages
Date of creation: Oct 2013
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Handle: RePEc:pav:demwpp:demwp0053
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