School of Economics and Finance

No. 518: Inflation Persistence Revisited

Marika Karanassou , Queen Mary, University of London
Dennis J. Snower , Birkbeck, University of London

September 1, 2004

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It is commonly asserted that inflation is a jump variable in the New Keynesian Phillips curve, and thus wage-price inertia does not imply inflation inertia. We show that this "inflation flexibility proposition" is highly misleading, relying on the assumption that real variables are exogenous. In a general equilibrium setting (in which real variables not only affect inflation, but are also influenced by it) the phenomenon of inflation inertia re-emerges. Under plausible parameter values, high degrees of inflation persistence (prolonged after-effects of inflation in response to temporary money growth shocks) and under-responsiveness (prolonged effects in response to permanent shocks) can arise in the context of standard wage-price staggering models.

J.E.L classification codes: E31, E32, E42, E63

Keywords:Inflation persistence, Wage-price staggering, New Keynesian Phillips curve, Nominal inertia, Monetary policy, Forward-looking expectations