Why Didn’t Inflation Collapse in the Great Recession?

Marco Del Negro, Marc Giannoni, Raiden B. Hasegawa and Frank Schorfheide

No 20140813, Liberty Street Economics from Federal Reserve Bank of New York

Abstract: GDP contracted 4 percent from 2008:Q2 to 2009:Q2, and the unemployment rate peaked at 10 percent in October 2010. Traditional backward-looking Phillips curve models of inflation, which relate inflation to measures of “slack” in activity and past measures of inflation, would have predicted a substantial drop in inflation. However, core inflation declined by only one percentage point, from 2.2 percent in 2007 to 1.2 percent in 2009, giving rise to the “missing deflation” puzzle. Based on this evidence, some authors have argued that slack must have been smaller than suggested by indicators such as the unemployment rate or deviations of GDP from its long-run trend. On the contrary, in Monday’s post, we showed that a New Keynesian DSGE model can explain the behavior of inflation in the aftermath of the Great Recession, despite large and persistent output gaps. An implication of this model is that information about the future stance of monetary policy is very important in determining current inflation, in contrast to backward-looking Phillips curve models where all that matters is the current and past stance of policy.

Keywords: Great Recession; DSGE Models; Missing Disinflation (search for similar items in EconPapers)
JEL-codes: E2 E5 G1 (search for similar items in EconPapers)
Date: 2014-08-13
New Economics Papers: this item is included in nep-mac and nep-mon
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