Still Minding the Gap—Inflation Dynamics during Episodes of Persistent Large Output Gaps
IMF Working Papers, August 1, 2010
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Bibliographic details
- Authors: Andre Meier
- Published: August 1, 2010
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781455202232.001
Overview
- Study of inflation dynamics during 25 historical episodes in advanced economies where output remained well below potential for an extended period.
- Paper author: Andre Meier.
- Publication date: August 1, 2010.
- Format: IMF Working Papers, Working Paper No. 2010/189.
Key findings
- Episodes generally brought about significant disinflation.
- Disinflation was underpinned by:
- weak labor markets,
- slowing wage growth,
- and, in many cases, falling oil prices.
- Inflation declined by about the same fraction of the initial inflation rate across episodes.
- Disinflation has tended to taper off at very low positive inflation rates, arguably reflecting downward nominal rigidities and well-anchored inflation expectations.
- Temporary inflation increases during episodes were systematically related to:
- currency depreciation,
- or higher oil prices.
- Overall conclusion: historical patterns suggest little upside inflation risk in advanced economies facing the prospect of persistent large output gaps.
Mechanisms and dynamics
- Labor market slack and slowing wage growth were central to the disinflationary process.
- Oil price movements contributed materially to episode-to-episode variation in inflation outcomes.
- Exchange rate depreciation acted as a driver of temporary inflation increases during these episodes.
- Downward nominal rigidities and well-anchored inflation expectations likely limited disinflation once inflation reached very low positive levels.
Policy implications
- Advanced-economy policymakers facing persistent large output gaps can expect:
- significant disinflationary pressures stemming from weak labor markets and slowing wages,
- limited upside inflation risk absent large oil price shocks or currency depreciations,
- potential stabilization of inflation at low positive rates due to nominal rigidities and anchored expectations.
- Monitoring oil prices and exchange rate developments is important for assessing temporary inflationary risks during prolonged output gaps.