Optimising Microfoundations for Inflation Persistence
Much recent monetary policy literature has searched for structural models suitable for policy analysis that are both based on optimising microfoundations and consistent with the data, especially observed persistence in inflation and output. Few models do well on both criteria. We derive an optimising model of the Phillips curve based on a generalised time dependent pricing rule, calibrate it using microeconomic evidence on price changing behaviour and simulate it with a standard discretionary policy maker. The model predicts inflation and output persistence comparable to that observed without reliance on rule of thumb behaviour or serially correlated shock processes.
We connect two major strands of the recent monetary policy literature, i) the search for well microfounded optimising models consistent with macroeconomic data, especially persistence in inflation, and ii) the wealth of newly available microeconomic data on price changing behaviour from the ECBâ€™s Inflation Persistence Network, alongside earlier firm surveys for the US, UK and Sweden. We develop a fully optimising Phillips curve following Goodfriend and King (NBER Macro Annual,1997) that may be calibrated to virtually any time dependent pricing rule but extended to include cost push shocks and the aggregation of sectors with different pricing rules. Analytical results include a tendency for aggregate dynamics to be driven by â€œstickierâ€ sectors. When calibrated to micro data the model predicts inflation persistence comparable to that in macro data with fully forward looking underlying pricing behaviour
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