The Inflation Output Trade-Off Revisited
A rich literature from the 1970s shows that as inflation expectations become more and more ingrained, monetary policy looses its stimulative effect. In the extreme, with perfectly anticipated inflation, there is no trade-off between inflation and output. A recent literature on the zero bound, however, suggests that there may be some benefits from anticipated inflation. In this paper, we reconcile these two insights by showing that while at positive interest rates, it is true that the more anticipated inflation becomes, the less stimulative it is, the opposite holds true at the zero bound. Indeed, at the zero bound, the more the public anticipates inflation, the greater is the effect of inflation on output. This leads us to revisit the trade-off between inflation and output, and to show how radically they may change in the face of large demand shocks. The case for inflation becomes much stronger: Instead of turning to zero once inflation becomes anticipated, the trade-off between inflation and output increase substantially and may become arbitrarily large.
|Date of creation:||2013|
|Date of revision:|
|Contact details of provider:|| Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA|
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