Kinked demand curves, the natural rate hypothesis, and macroeconomic stability

Takushi Kurozumi and Willem Van Zandweghe

No RWP 13-08, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: In the presence of staggered price setting, high trend inflation induces a large deviation of steady-state output from its natural rate and indeterminacy of equilibrium under the Taylor rule. This paper examines the implications of a ''smoothed-off'' kink in demand curves for the natural rate hypothesis and macroeconomic stability using a canonical model with staggered price setting, and sheds light on the relationship between the hypothesis and the Taylor principle. An empirically plausible calibration of the model shows that the kink in demand curves mitigates the influence of price dispersion on aggregate output, thereby ensuring that the violation of the natural rate hypothesis is minor and preventing fluctuations driven by self-fulfilling expectations under the Taylor rule.

Pages: 34 pages
Date: 2013
New Economics Papers: this item is included in nep-lam, nep-ltv, nep-mac and nep-neu
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Citations: View citations in EconPapers (9)

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Journal Article: Kinked Demand Curves, the Natural Rate Hypothesis, and Macroeconomic Stability (2016)
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