Working Paper: CEPR ID: DP5608
Authors: Prakriti Sofat; Patrick Minford; Naveen Srinivasan; Eric Nowell
Abstract: A large econometric literature has found that post-war US inflation exhibits very high persistence, approaching that of a random walk process. Given similar evidence for other OECD countries, many macroeconomists have concluded that high inflation persistence is a 'stylized fact'. The objective of this paper is to show that degree of inflation persistence is not an inherent structural characteristic of an economy, but in fact a function of the stability and transparency of monetary policy regime in place. We begin by estimating univariate processes for inflation across different periods, allowing for structural breaks based on a priori knowledge of the UK economy. Then we examine whether, a rather straightforward model, easily micro-founded in a standard classical set-up can generate the facts such as we find them. We calibrate our structural model for each of the regimes and solve it analytically for the implied persistence in the inflation process. We compare this theoretical prediction with the estimated persistence for each regime. Finally we bootstrap our model to generate pseudo inflation series and check whether the actual persistence coefficients lie within the 95 percent confidence limits implied by the bootstraps. As a robustness exercise we do the same for the Liverpool model.
Keywords: bootstraps; inflation
JEL Codes: E0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy regime (E63) | inflation persistence (E31) |
| exogenous error processes (C51) | inflation persistence (E31) |
| inflation targeting (E31) | inflation persistence (E31) |
| Bretton Woods era (F33) | inflation persistence (E31) |
| incomes policy regime (E64) | inflation persistence (E31) |
| changes in policy (O24) | inflation persistence (E31) |