Working Paper

A Theory of Intrinsic Inflation Persistence

Abstract: We propose a novel theory of intrinsic inflation persistence by introducing trend inflation and variable elasticity of demand in a model with staggered price and wage setting. Under nonzero trend inflation, the variable elasticity generates intrinsic persistence in inflation through a measure of price dispersion stemming from staggered price setting. It also introduces intrinsic persistence in wage inflation under staggered wage setting, which affects price inflation. With the theory we show that inflation exhibits a persistent, hump-shaped response to a monetary policy shock. We also show that a credible disinflation leads to a gradual decline in inflation and a fall in output, and lower trend inflation reduces inflation persistence, as observed around the time of the Volcker disinflation.

Keywords: intrinsic inflation persistence; variable elasticity of demand; Trend inflation; credible disinflation; price dispersion;

JEL Classification: E31; E52;

https://doi.org/10.26509/frbc-wp-201916

Bibliographic Information

Provider: Federal Reserve Bank of Cleveland

Part of Series: Working Papers

Publication Date: 2019-08-29

Number: 19-16