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Escaping Volatile Inflation
Author(s) -
ELLISON MARTIN,
YATES TONY
Publication year - 2007
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.1538-4616.2007.00054.x
Subject(s) - economics , keynesian economics , inflation (cosmology) , monetary economics , volatility (finance) , real interest rate , monetary policy , government (linguistics) , macroeconomics , economic stability , econometrics , linguistics , philosophy , physics , theoretical physics
Why has inflation been so stable in developed economies since the early 1990s? In this paper, we answer that the United States and other countries may have escaped from a volatile inflation equilibrium. Our argument builds on the story proposed by Tom Sargent in The Conquest of American Inflation , where the fall in inflation in the 1980s was attributed to changing government beliefs. To explain the escape in inflation volatility, we unwind one of Sargent's simplifications and allow the government to react to some of the shocks in the economy. In this case, when government beliefs turned against the Phillips curve in the 1980s they not only led to an escape from high inflation, but also stopped government using changes in inflation to offset shocks. Inflation and inflation volatility therefore escaped in tandem. Our analysis also sheds some light on why the escape in inflation occurred at the time it did.