The Macroeconomics of Trend Inflation

Abstract

Most macroeconomic models for monetary policy analysis are approximated around a zero inflation steady state, but most central banks target an inflation rate of about 2 percent. Many economists have recently proposed even higher inflation targets to reduce the incidence of the zero lower bound constraint on monetary policy. In this survey, we show that the conduct of monetary policy should be analyzed by appropriately accounting for the positive trend inflation targeted by policymakers. We first review empirical research on the evolution and dynamics of U.S. trend inflation and some proposed new measures to assess the volatility and persistence of trend-based inflation gaps. We then construct a Generalized New Keynesian model that accounts for a positive trend inflation. In this model an increase in trend inflation is associated with a more volatile and unstable economy and tends to destabilize inflation expectations. This analysis offers a note of caution regarding recent proposals to address the existing zero lower bound problem by raising the long-run inflation target.

Demographics and Real Interest Rates: Inspecting the Mechanism

“…However, the benefits of higher inflation must be weighted against its welfare costs, such as those stemming from higher price dispersion (e.g., Ascari and Sbordone 2014), and the distributional effects (Doepke and Schneider, 2006). A second implication is perhaps slightly more subtle.…”

The Equity Premium, Long-Run Risk, & Optimal Monetary Policy

“…Inflation will also erode the real value of any markup established at time t, so that per-unit profits will decline for as long as the firm is stuck. Ascari and Sbordone (2013) show that as trend inflation increases, the increase in the marginal markup dominates so that the overall average markup also rises. As the average markup rises, output declines along with welfare.…”

Ambiguity, Monetary Policy and Trend Inflation

“…The anticipated-utility approximation we exploit implies that agents treat µ t and µ t as constants for the purpose of computing expectations, an assumption commonly adopted in the study of trend inflation (see for example Ascari and Sbordone, 2014). This very stark relation implied by our model can be brought to the data in a very simple way.…”