Variable Elasticity Demand and Inflation Persistence

By Willem Van Zandweghe, Assistant Vice President and Economist and Takushi Kurozumi


Download paper, RWP 16-09, April 2018

We propose a novel explanation for the well-known persistent inflation response to monetary policy shocks by introducing variable elasticity demand curves in a staggered price model with trend inflation. The demand curves induce strategic complementarity in price setting and thus generate inflation persistence under positive trend inflation through the effect on inflation dynamics of a measure of price dispersion, which differs from relative price distortion. We also show that credible disinflation leads to a gradual decline in inflation and a fall in output and that lower trend inflation reduces inflation persistence, as observed around the time of the Volcker disinflation.

JEL Classification: E31, E52

Article Citation

  • Kurozumi, Takushi, and Willem Van Zandweghe. “Variable Elasticity Demand and Inflation Persistence,” Federal Reserve Bank of Kansas City working paper no. 16-09, April 2018, available at https://doi.org/10.18651/RWP2016-09

Related Research

  • Christiano, Lawrence J., Martin Eichenbaum, and Charles L. Evans. 2005. “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,” Journal of Political Economy 113(1), 1-45. Available at: http://doi.org/10.1086/426038
  • Damjanovic, Tatiana, and Charles Nolan. 2010. “Relative Price Distortions and Inflation Persistence,” Economic Journal 120(547), 1080-1099. Available at: http://doi.org//10.1111/j.1468-0297.2009.02329.x
  • Fuhrer, Jeffrey C. 2011. “Inflation Persistence”' In: B. M. Friedman and M. Woodford (Eds.), Handbook of Monetary Economics, Vol. 3A, Elsevier, North Holland, pp. 423-486. Available at: http://doi.org/10.1016/B978-0-444-53238-1.00009-0

About the Author

Willem Van Zandweghe conducts research on business fluctuations, inflation dynamics, and monetary policy.