Inflation-Gap Persistence in the US

TLDR

The study interprets changes in inflation‑gap persistence using a dynamic New Keynesian model that emphasizes the role of central bank inflation targeting. The study estimates vector autoregressions with drifting coefficients and stochastic volatility to investigate whether US inflation persistence has changed. The authors estimate vector autoregressions with drifting coefficients and stochastic volatility, focus on the inflation gap defined as the deviation from trend inflation, and measure its short‑to‑medium‑term predictability, interpreting results with a dynamic New Keynesian model. Evidence shows that inflation‑gap persistence rose during the Great Inflation and declined after the Volcker disinflation. JEL classification: E12, E31, E52, E58.

Abstract

We estimate vector autoregressions with drifting coefficients and stochastic volatility to investigate whether US inflation persistence has changed. We focus on the inflation gap, defined as the difference between inflation and trend inflation, and we measure persistence in terms of short- to medium-term predictability. We present evidence that inflation-gap persistence increased during the Great Inflation and that it fell after the Volcker disinflation. We interpret these changes using a dynamic new Keynesian model that highlights the importance of changes in the central bank's inflation target. (JEL E12, E31, E52, E58)