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The Effects of Trend Inflation on Aggregate Dynamics and Monetary Stabilization

Author

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  • Andrey Alexandrov
Abstract
I derive a set of new analytic results for the effects of trend inflation on aggregate price and output dynamics in menu cost models. I find that positive trend inflation: (1) induces asymmetry in price and output responses to monetary shocks, (2) leads to price overshooting after large shocks, and (3) destroys the monetary neutrality result for large shocks. Under positive trend inflation, large expansionary monetary interventions lead to output contractions, and smaller expansionary interventions have substantially reduced potency. Using U.S. sectoral data, I provide supporting evidence for these model predictions. Calibrating a general equilibrium model to the U.S. economy, I find sizable effects of trend inflation on monetary stabilization policy. Raising the inflation target from 2% to 4% increases the economy's sensitivity to an adverse markup shock and worsens the stabilization trade-off.

Suggested Citation

  • Andrey Alexandrov, 2020. "The Effects of Trend Inflation on Aggregate Dynamics and Monetary Stabilization," CRC TR 224 Discussion Paper Series crctr224_2020_216, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2020_216
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp216
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    Citations

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    Cited by:

    1. Fernando Alvarez & Francesco Lippi, 2022. "The Analytic Theory of a Monetary Shock," Econometrica, Econometric Society, vol. 90(4), pages 1655-1680, July.
    2. Fernando Alvarez & Francesco Lippi & Aleksei Oskolkov, 2022. "The Macroeconomics of Sticky Prices with Generalized Hazard Functions [“Optimal Inattention to the Stock Market With Information Costs and Transactions Costs,”]," The Quarterly Journal of Economics, Oxford University Press, vol. 137(2), pages 989-1038.
    3. Isaac Baley & Andrés Blanco, 2021. "Aggregate Dynamics in Lumpy Economies," Econometrica, Econometric Society, vol. 89(3), pages 1235-1264, May.
    4. Fernando Alvarez & Andrea Ferrara & Erwan Gautier & Hervé Le Bihan & Francesco Lippi, 2021. "Empirical Investigation of a Sufficient Statistic for Monetary Shocks," Working papers 839, Banque de France.
    5. Fernando Alvarez & Francesco Lippi & Aleksei Oskolkov, 2023. "The Macroeconomics of Sticky Prices with Generalized Hazard Functions," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 137(2), pages 989-1038.
    6. Karadi, Peter & Nakov, Anton & Nuño, Galo & Pasten, Ernesto & Thaler, Dominik, 2024. "Strike while the Iron is Hot: Optimal Monetary Policy with a Nonlinear Phillips Curve," CEPR Discussion Papers 19339, C.E.P.R. Discussion Papers.
    7. Hong, Gee Hee & Klepacz, Matthew & Pasten, Ernesto & Schoenle, Raphael, 2023. "The real effects of monetary shocks: Evidence from micro pricing moments," Journal of Monetary Economics, Elsevier, vol. 139(C), pages 1-20.

    More about this item

    Keywords

    trends; asymmetry; trend inflation; aggregate dynamics;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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