Discussion paper

DP13690 Resolving the Missing Deflation Puzzle

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.


Lindé, J and M Trabandt (2019), ‘DP13690 Resolving the Missing Deflation Puzzle‘, CEPR Discussion Paper No. 13690. CEPR Press, Paris & London. https://cepr.org/publications/dp13690