Template-Type: ReDIF-Paper 1.0
Title: The Effects of Trend Inflation on Aggregate Dynamics and Monetary Stabilization
Author-Name: Andrey Alexandrov
Author-Email: andrey.alexandrov@gess.uni-mannheim.de

Classification-JEL: E32, E52
Keywords: trends, asymmetry, trend inflation, aggregate dynamics

Abstract: I derive a set of new analytic results for the effects of trend inflation on aggregate price and output dynamics in menu cost models. I find that positive trend inflation: (1) induces asymmetry in price and output responses to monetary shocks, (2) leads to price overshooting after large shocks, and (3) destroys the monetary neutrality result for large shocks. Under positive trend inflation, large expansionary monetary interventions lead to output contractions, and smaller expansionary interventions have substantially reduced potency. Using U.S. sectoral data, I provide supporting evidence for these model predictions. Calibrating a general equilibrium model to the U.S. economy, I find sizable effects of trend inflation on monetary stabilization policy. Raising the inflation target from 2% to 4% increases the economy's sensitivity to an adverse markup shock and worsens the stabilization trade-off.

Note: 
Length: 92
Creation-Date: 2020-10
Revision-Date: 
File-URL: https://www.crctr224.de/research/discussion-papers/archive/dp216
File-Format: application/pdf
Handle: RePEc:bon:boncrc:CRCTR224_2020_216