Price Dispersion and Inflation Persistence

27 Pages Posted: 26 Oct 2016

See all articles by Takushi Kurozumi

Takushi Kurozumi

Bank of Japan

Willem Van Zandweghe

Federal Reserve Bank of Kansas City

Date Written: October 2016

Abstract

Persistent responses of inflation to monetary policy shocks have been difficult to explain by existing models of the monetary transmission mechanism without embedding controversial intrinsic inertia of inflation. Our paper addresses this issue using a staggered price model with trend inflation, a smoothed-off kink in demand curves, and a fixed cost of production. In this model, inflation exhibits a persistent response to a policy shock even in the absence of its intrinsic inertia, because the kink causes a measure of price dispersion, which is intrinsically inertial, to become a key source of in- flation persistence under the positive trend inflation rate. In addition, output and labor productivity both rise after an expansionary policy shock as in an estimated structural vector autoregression model. Moreover, credible disinflation induces a gradual decline in inflation and a fall in output as observed during the Volcker disinflation era.

Keywords: Staggered Price Setting; Trend inflation; Smoothed-Off Kink in Demand Curve; Fixed Production Cost; Monetary Policy Shock; Credible Disinflation

JEL Classification: E31; E52

Suggested Citation

Kurozumi, Takushi and Van Zandweghe, Willem, Price Dispersion and Inflation Persistence (October 2016). Federal Reserve Bank of Kansas City Working Paper No. 16-09. Available at SSRN: https://ssrn.com/abstract=2859119

Takushi Kurozumi (Contact Author)

Bank of Japan ( email )

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

Willem Van Zandweghe

Federal Reserve Bank of Kansas City ( email )

1 Memorial Drive
Kansas City, MO 64198
United States

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