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.

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Citation

Linde, J and M Trabandt (eds) (2019), “DP13690 Resolving the Missing Deflation Puzzle”, CEPR Press Discussion Paper No. 13690. https://cepr.org/publications/dp13690