Working Paper: CEPR ID: DP13690
Authors: Jesper Lind; Mathias Trabandt
Abstract: We propose a resolution of the missing deflation puzzle. Our resolution stresses the importance of nonlinearities in price- and wage-setting when the economy is exposed to large shocks. We show that a nonlinear macroeconomic model with real rigidities resolves the missing deflation puzzle, while a linearized version of the same underlying nonlinear model fails to do so. In addition, our nonlinear model reproduces the skewness of inflation and other macroeconomic variables observed in post-war U.S. data. All told, our results caution against the common practice of using linearized models to study inflation and output dynamics.
Keywords: Great Recession; Inflation Dynamics; Liquidity Trap; Zero Lower Bound; Linearized Model Solution; Nonlinear Model Solution; Strategic Complementarities; Real Rigidities
JEL Codes: E30; E31; E32; E37; E44; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real rigidities (D43) | inflation dynamics (E31) |
| nonlinear model (C51) | inflation dynamics (E31) |
| linearized model (C51) | inflation dynamics (E31) |
| nonlinear model (C51) | skewness of inflation (E31) |
| linear approximation (C51) | misrepresentation of inflation (E31) |
| nonlinear model (C51) | banana-shaped Phillips curve (E31) |