IMF Working Papers

Monetary Policy and Inflation Scares

By Christopher J. Erceg, Jesper Lindé, Mathias Trabandt

December 20, 2024

Download PDF More Formats on IMF eLibrary Order a Print Copy
More formats on IMF eLibrary Order a Print Copy

Preview Citation

Format: Chicago

Christopher J. Erceg, Jesper Lindé, and Mathias Trabandt. "Monetary Policy and Inflation Scares", IMF Working Papers 2024, 260 (2024), accessed March 25, 2025, https://doi.org/10.5089/9798400295287.001

Export Citation

  • ProCite
  • RefWorks
  • Reference Manager
  • BibTex
  • Zotero
  • EndNote

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

A salient feature of the post-COVID inflation surge is that economic activity has remained resilient despite unfavorable supply-side developments. We develop a macroeconomic model with nonlinear price and wage Phillips curves, endogenous intrinsic indexation and an unobserved components representation of a cost-push shock that is consistent with these observations. In our model, a persistent large adverse supply shock can lead to a persistent inflation surge while output expands if the central bank follows an inflation forecast-based policy rule and thus abstains from hiking policy rates for some time as it (erroneously) expects inflationary pressures to dissipate quickly. A standard linearized formulation of our model cannot account for these observations under identical assumptions. Our nonlinear framework implies that the standard prescription of "looking through" supply shocks is a good policy for small shocks when inflation is near the central bank's target, but that such a policy may be quite risky when economic activity is strong and large shocks drive inflation well above target. Moreover, our model implies that the economic costs of "going the last mile" – i.e. a tight stance aimed at returning inflation quickly to target – can be substantial.

Subject: Central bank policy rate, Economic theory, Financial services, Inflation, Inflation targeting, Labor, Labor markets, Monetary policy, Prices, Supply shocks

Keywords: Central bank policy rate, Cost-push shock, COVID inflation surge, Inflation, Inflation Dynamics, Inflation Risk, Inflation targeting, Labor markets, Linearized Model, Monetary Policy, New Keynesian Model, Nonlinear Model, Policy rule, State-Dependent Pricing, Supply shocks

Publication Details

You May Also Be Interested In...

Slovak Republic: 2025 Article IV Consultation-Press Release; and Staff Report

March 24, 2025

Slovak Republic: Financial System Stability Assessment

March 24, 2025

Slovak Republic: Selected Issues

March 24, 2025

Republic of Madagascar: Staff Report for the 2024 Article IV Consultation; First Review Under the Extended Credit Facility Arrangement; Request for A Waiver of Nonobservance of Performance Criteria; and Financing Assurances Review; and First Review Under the Arrangement Under the Resilience and Sustainability Facility-Press Release; Staff Report; and Statement by the Executive Director for Republic of Madagascar

March 21, 2025