Working Paper: NBER ID: w0518
Authors: Zvi Hercowitz
Abstract: This paper examines the effects of expected inflation on the responsiveness of output to nominal disturbances in the framework of a localized markets model. The mechanism described in the theoretical part of the paper is that expected inflation has a positive effect on the transaction frequency, which in turn increases the flow of price information across markets. More information implies less misperception of monetary shocks as relative shifts in excess demand, resulting in lower sensitivity of real output to these socks. The empirical implication of this proposition -- namely ,that expected inflation reduces the coefficient of nominal shocks in an output equation -- is tested first using data across countries, and then with time series data from the United States. The first test uses Lucas's and Alberro's estimates of Phillips Curve coefficients from different countries and the corresponding average inflation rates. The second test involves data from the post-World War II period. It uses nominal rates of return on Treasury Bills and corporate bonds as measures of anticipated inflation and Barro's estimates of unanticipated money. In general, results in both tests provide support (stronger than expected)for the implication of the theory.
Keywords: anticipated inflation; Phillips curve; transaction frequency; nominal shocks
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Expected Inflation (E31) | Transaction Frequency (E50) |
| Transaction Frequency (E50) | Flow of Price Information (E30) |
| Flow of Price Information (E30) | Reduced Misperception of Monetary Shocks (E39) |
| Reduced Misperception of Monetary Shocks (E39) | Lower Sensitivity of Real Output to Nominal Shocks (E39) |
| Expected Inflation (E31) | Lower Sensitivity of Real Output to Nominal Shocks (E39) |