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Inflation Persistence and Flexible Prices

  • Robert Dittmar
  • William Gavin
  • Finn Kydland

If the central bank follows an interest rate rule, then inflation is likely to be persistence, even when prices are fully flexible. Any shock, whether persistent or not, may lead to inflation persistence. In equilibrium, the dynamics of inflation are determined by the evolution of the spread between the real interest rate and the central bank’s target. Inflation persistence in U.S. data can be characterized by a vector autocorrelation function relating inflation and deviations of output from trend. This paper shows that a flexible-price general equilibrium business cycle model with money and a central bank using an interest rate target can account for such inflation persistence.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2002 with number 190.

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Date of creation: 01 Jul 2002
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Handle: RePEc:sce:scecf2:190
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  1. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  2. Casey B. Mulligan & Xavier X. Sala-i-Martin & Frederic S. Mishkin & Jonas D. M. Fisher, 1997. "The optimum quantity of money: theory and evidence," Proceedings, Federal Reserve Bank of Cleveland, pages 687-724.
  3. David E. Runkle, 1987. "Vector autoregressions and reality," Staff Report 107, Federal Reserve Bank of Minneapolis.
  4. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  5. Gary D. Hansen & Edward C. Prescott, 1992. "Recursive methods for computing equilibria of business cycle models," Discussion Paper / Institute for Empirical Macroeconomics 36, Federal Reserve Bank of Minneapolis.
  6. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
  7. Runkle, David E, 1987. "Vector Autoregressions and Reality," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(4), pages 437-42, October.
  8. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  9. Robert E. Lucas, Jr., 2000. "Inflation and Welfare," Econometrica, Econometric Society, vol. 68(2), pages 247-274, March.
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