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Discussion Paper Details

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Title: Resolving the Missing Deflation Puzzle

Author(s): Jesper Lind� and Mathias Trabandt

Publication Date: April 2019

Keyword(s): great recession, inflation dynamics, linearized model solution, liquidity trap, nonlinear model solution, Real rigidities, strategic complementarities and zero lower bound

Programme Area(s): Monetary Economics and Fluctuations

Abstract: We propose a resolution of the missing deflation puzzle. Our resolution stresses the importance of nonlinearities in price- and wage-setting when the economy is exposed to large shocks. We show that a nonlinear macroeconomic model with real rigidities resolves the missing deflation puzzle, while a linearized version of the same underlying nonlinear model fails to do so. In addition, our nonlinear model reproduces the skewness of inflation and other macroeconomic variables observed in post-war U.S. data. All told, our results caution against the common practice of using linearized models to study inflation and output dynamics.

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Bibliographic Reference

Lind�, J and Trabandt, M. 2019. 'Resolving the Missing Deflation Puzzle'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=13690