Download this Paper Open PDF in Browser

Kinked Demand Curves, the Natural Rate Hypothesis, and Macroeconomic Stability

46 Pages Posted: 15 Jan 2014 Last revised: 13 Feb 2015

Takushi Kurozumi

Bank of Japan

Willem Van Zandweghe

Federal Reserve Bank of Kansas City

Date Written: February 2015

Abstract

In the presence of staggered price setting, high trend inflation induces a large deviation of steady-state output from its natural rate and indeterminacy of equilibrium under the Taylor rule. This paper examines the implications of a ''smoothed-off'' kink in demand curves for the natural rate hypothesis and macroeconomic stability using a canonical model with staggered price setting, and sheds light on the relationship between the hypothesis and the Taylor principle. An empirically plausible calibration of the model shows that the kink in demand curves mitigates the influence of price dispersion on aggregate output, thereby ensuring that the violation of the natural rate hypothesis is minor and preventing fluctuations driven by self-fulfilling expectations under the Taylor rule.

Keywords: Smoothed-off kink in demand curve, Trend inflation, Price dispersion, Natural rate hypothesis, Taylor principle

JEL Classification: E31, E52

Suggested Citation

Kurozumi, Takushi and Van Zandweghe, Willem, Kinked Demand Curves, the Natural Rate Hypothesis, and Macroeconomic Stability (February 2015). Federal Reserve Bank of Kansas City Working Paper No. 13-08. Available at SSRN: https://ssrn.com/abstract=2379108 or http://dx.doi.org/10.2139/ssrn.2379108

Takushi Kurozumi

Bank of Japan ( email )

2-1-1 Hongoku-cho
Nihonbashi
Chuo-ku Tokyo 103-8660
Japan

Willem Van Zandweghe (Contact Author)

Federal Reserve Bank of Kansas City ( email )

1 Memorial Drive
Kansas City, MO 64198
United States

Paper statistics

Downloads
16
Abstract Views
358