Alternative Sources of the Lag Dynamics of Inflation

By Sharon Kozicki and P.A. Tinsley
December 2002 
RWP 02-12
Research Division 
Federal Reserve Bank of Kansas City 

Abstract

      This paper discusses four potential sources of lag dynamics in inflation: non-rational behavior, staggered contracting, frictions on price adjustment, and shifts in the long-run inflation anchor of agent expectations (the perceived inflation target). Expressions for inflation dynamics from structural models which admit these different sources of lag dynamics are contrasted. Empirical results are provided for the U.S. and Canada. The empirical evidence suggests that shifts in the perceived inflation target of monetary policy, less than full policy credibility, and inflation stickiness have all been important features of the historical behavior of inflation.

Keywords:  Inflation persistence, policy credibility, Phillips curve, perceived inflation target, shifting endpoint, staggered contracts, adjustment costs

JEL Codes:  E31, E52, D8

Sharon Kozicki is an assistant vice president and economist at the Federal Reserve Bank of Kansas City. P.A. Tinsley is a lecturer on the Faculty of Economics and Politics at the University of Cambridge, Cambridge, England. This paper was prepared for the Bank of Canada conference on Price Adjustment and Monetary Policy, November 14-15, 2002. The authors benefited from conversations with Mark Gertler, Jon Willis, and Pu Shen while preparing this paper. The authors would also like to thank Michael Woodford, Bennett McCallum, Michael Dotsey, Hashmat Khan, and Todd Clark for comments, Christian Upper for providing an electronic compilation of the Consensus Forecasts data, and Bob Arnold for supplying quarterly CBO estimates of potential output for the U.S. Matthew Cardillo provided excellent research assistance. The views expressed in this paper are those of the authors and do not necessarily represent the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System.

Kozicki e-mail:  sharon.kozicki@kc.frb.org
Tinsley e-mail:  ptinsley@econ.cam.ac.uk

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