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Trend Inflation Meets Macro-Finance: The Puzzling Behavior of Price Dispersion

Author

Listed:
  • Ales Marsal

    (Narodna banka Slovenska, Bratislava, Slovakia)

  • Katrin Rabitsch

    (Vienna University of Economics and Business, Vienna, Austria)

  • Lorant Kaszab

    (Magyar Nemzeti Bank, Budapest, Hungary)

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 of Rudebusch and Swanson (2012). 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.

Suggested Citation

  • Ales Marsal & Katrin Rabitsch & Lorant Kaszab, 2019. "Trend Inflation Meets Macro-Finance: The Puzzling Behavior of Price Dispersion," Working and Discussion Papers WP 6/2019, Research Department, National Bank of Slovakia.
    • Handle: RePEc:svk:wpaper:1064
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    References listed on IDEAS

    as
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    Cited by:

    1. Iania, Leonardo & Tretiakov, Pavel & Wouters, Rafael, 2023. "The risk premium in New Keynesian DSGE models: The cost of inflation channel," Journal of Economic Dynamics and Control, Elsevier, vol. 155(C).
    2. Ales Marsal & Katrin Rabitsch & Lorant Kaszab, 2023. "From Linear to Nonlinear: Rethinking Inflation Dynamics in the Calvo Pricing Mechanism," Department of Economics Working Papers wuwp350, Vienna University of Economics and Business, Department of Economics.

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    More about this item

    Keywords

    trend inflation; Calvo pricing; price dispersion; macro-finance; asset pricing;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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