Trend inflation meets macro-finance: the puzzling behavior of price dispersion

Kaszab, Lorant and Marsal, Ales and Rabitsch, Katrin (2020) Trend inflation meets macro-finance: the puzzling behavior of price dispersion. Department of Economics Working Paper Series, 304. WU Vienna University of Economics and Business, Vienna.


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Motivated by recent empirical findings that emphasize low-frequency movements in inflation as a key determinant of term structure, we introduce trend inflation into the workhorse macro-finance model. We show that this compromises the earlier model success and delivers implausible business cycle and bond price dynamics. We document that this result applies more generally to non-linearly solved models with Calvo pricing and trend inflation and is driven by the behavior of price dispersion, which is i) counterfactually high and ii) highly inaccurately approximated. We highlight the channels behind the undesired performance under trend inflation and propose several remedies.

Item Type: Paper
Additional Information: The authors gratefully acknowledge financial support from the Austrian National Bank, Jubilaeumsfond Grant No. 17791.
Keywords: trend inflation, Calvo pricing, price dispersion, macro-finance, non-linear solution methods
Classification Codes: JEL E13, E31, E43, E44
Divisions: Departments > Volkswirtschaft
Depositing User: Claudia Tering-Raunig
Date Deposited: 30 Oct 2020 08:48
Last Modified: 30 Oct 2020 08:49


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