Inflation Dynamics and the Great Recession

Author/Editor: Sandeep Mazumder ; Laurence M. Ball
Publication Date: June 01, 2011
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
Summary: This paper examines inflation dynamics in the United States since 1960, with a particular focus on the Great Recession. A puzzle emerges when Phillips curves estimated over 1960-2007 are ussed to predice inflation over 2008-2010: inflation should have fallen by more than it did. We resolve this puzzle with two modifications of the Phillips curve, both suggested by theories of costly price adjustment: we measure core inflation with the median CPI inflation rate, and we allow the slope of the Phillips curve to change with the level and vairance of inflation. We then examine the hypothesis of anchored inflation expectations. We find that expectations have been fully "shock-anchored" since the 1980s, while "level anchoring" has been gradual and partial, but significant. It is not clear whether expectations are sufficiently anchored to prevent deflation over the next few years. Finally, we show that the Great Recession provides fresh evidence against the New Keynesian Phillips curve with rational expectations.
Series: Working Paper No. 11/121
Subject(s): Consumer price indexes | Economic models | Economic recession | Inflation rates | Price adjustments | Price increases

Author's Keyword(s): Inflation | Phillips curve | Great Recession
Publication Date: June 01, 2011
ISBN/ISSN: 9781455263387/1018-5941 Format: Paper
Stock No: WPIEA2011121 Pages: 56
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