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Trend inflation meets macro-finance: the puzzling behavior of price dispersion

Lorant Kaszab (), Aleš Maršál () and Katrin Rabitsch ()

No 304, Department of Economics Working Paper Series from WU Vienna University of Economics and Business

Abstract: Motivated by recent empirical findings that emphasize low-frequency movements in inflation as a key determinant of term structure, we introduce trend inflation into the workhorse macro-finance model. We show that this compromises the earlier model success and delivers implausible business cycle and bond price dynamics. We document that this result applies more generally to non-linearly solved models with Calvo pricing and trend inflation and is driven by the behavior of price dispersion, which is i) counterfactually high and ii) highly inaccurately approximated. We highlight the channels behind the undesired performance under trend inflation and propose several remedies.

Keywords: trend inflation; Calvo pricing; price dispersion; macro-finance; non-linear solution methods (search for similar items in EconPapers)
Date: 2020-10
New Economics Papers: this item is included in nep-cba and nep-mac
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Related works:
Working Paper: Trend inflation meets macro-finance: the puzzling behavior of price dispersion (2020) Downloads
Working Paper: Trend Inflation Meets Macro-Finance: The Puzzling Behavior of Price Dispersion (2019) Downloads
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