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Inflation Gap Persistence, Indeterminacy, and Monetary Policy

Yasuo Hirose, Takushi Kurozumi () and Willem Van Zandweghe ()

No 202105, Working Papers from Federal Reserve Bank of Cleveland

Abstract: Empirical studies have documented that the persistence of the gap between inflation and its trend declined after the Volcker disinflation. Previous research into the source of the decline has offered competing views while sidestepping the possibility of equilibrium indeterminacy. This paper examines the source by estimating a medium-scale DSGE model using a Bayesian method that allows for indeterminacy. The estimated model shows that the Fed's change from a passive to an active policy response to the inflation gap or a decrease in firms' probability of price change can fully account for the decline in inflation gap persistence by ruling out indeterminacy that induces persistent dynamics of the economy.

Keywords: Inflation gap persistence; Predictability; Equilibrium indeterminacy; Monetary policy; Non-CES aggregator (search for similar items in EconPapers)
JEL-codes: C62 E31 E52 (search for similar items in EconPapers)
Pages: 53
Date: 2021-02-22
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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DOI: 10.26509/frbc-wp-202105

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