Cover IMF Working Papers
How Costly Will Reining in Inflation Be? It Depends on How Rational We Are
Author:
Mr. Jorge A Alvarez 0000000404811396 https://isni.org/isni/0000000404811396 International Monetary Fund

Search for other papers by Mr. Jorge A Alvarez in
Current site
Google Scholar
PubMedClose
and
Allan Dizioli
Search for other papers by Allan Dizioli in
Current site
Google Scholar
PubMedClose
Series:
IMF Working Papers
Volume/Issue:
Volume 2023: Issue 021
Language:
English
Publication Date:
03 Feb 2023
DOI:
https://doi.org/10.5089/9798400232275.001
ISBN:
9798400232275
ISSN:
1018-5941
Pages:
37
Keywords:
DSGE; inflation dynamics; optimal monetary policy; forecasting and simulation; bayesian estimation; inflation-slack curve; expectations drift; shock decomposition; inflation episode; Inflation; Output gap; Real wages; Wage gap; Wages; Global
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Download PDF (3.8 MB) Download Epub
We document that past highly inflationary episodes are often characterized by a steeper inflationslack relationship. We show that model-generated data from a standard small Dynamic Stochastic General Equilibrium (DSGE) model can replicate this empirical finding when estimated with different expectation formation processes. When inflation becomes de-anchored and expectations drift, we can observe high inflation even with a mildly positive output gap in response to cost-push shocks. The results imply that we should not use an unconditioned (not controlling for expectations change) Phillips curve estimated in normal times to predict the cost of reining in inflation. Our optimal policy exercises prescribe early monetary policy tightening and then easing in the context of positive output gaps and inflation far above the central bank target.
  • Collapse
  • Expand
Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund
Volume 2023: Issue 021