Price Dispersion and Inflation Persistence

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


Download paper, RWP 16-09, October 2016

Persistent responses of inflation to monetary policy shocks have been difficult to explain by existing models of the monetary transmission mechanism without embedding controversial intrinsic inertia of inflation. Our paper addresses this issue using a staggered price model with trend inflation, a smoothed-off kink in demand curves, and a fixed cost of production. In this model, inflation exhibits a persistent response to a policy shock even in the absence of its intrinsic inertia, because the kink causes a measure of price dispersion, which is intrinsically inertial, to become a key source of inflation persistence under the positive trend inflation rate. In addition, output and labor productivity both rise after an expansionary policy shock as in an estimated structural vector autoregression model. Moreover, credible disinflation induces a gradual decline in inflation and a fall in output as observed during the Volcker disinflation era.

JEL Classification: E31, E52

Article Citation

  • Kurozumi, Takushi, and Willem Van Zandweghe. “Price Dispersion and Inflation Persistence,” Federal Reserve Bank of Kansas City working paper no. 16-09, October, 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.