What Drives Low and Stable Inflation?

Joshua Brault and Louis Phaneuf
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Joshua Brault: Bank of Canada
Louis Phaneuf: University of Quebec in Montreal

No 25-02, Working Papers from Chair in macroeconomics and forecasting, University of Quebec in Montreal's School of Management

Abstract: We answer this question by estimating New Keynesian (NK) models with positive trend inflation using Bayesian methods. The models estimated differ by the degree of interest-rate smoothing, measures of the inflation gap and economic activity the Fed targets in setting the policy rate, and the persistence (or lack thereof) of monetary policy shocks. We use time-series covering three different inflationary periods ranging in the US from 1964 to 2022. Our evidence indicates that inflation stability did not likely result from a much stronger Fed's response to the inflation gap. It points instead to a moderate increase in the Fed's response, combined predominantly with smaller movements in the inflation target. We identify second-order interest-rate smoothing, a time-varying inflation target, a policy response to output growth, and mildly persistent monetary policy shocks as important factors driving our findings.

Keywords: Bayesian estimation; Taylor rules; second-order interest-smoothing; time-varying target inflation; output growth targeting; persistent policy shocks; determinacy (search for similar items in EconPapers)
JEL-codes: E31 E32 E37 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2025-02, Revised 2025-02
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Persistent link: https://EconPapers.repec.org/RePEc:bbh:wpaper:25-02

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