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Working Paper

Inflation Gap Persistence, Indeterminacy, and Monetary Policy

Empirical studies have documented that the persistence of the gap between inflation and its trend declined after the Volcker disinflation. Previous research into the source of the decline has offered competing views while sidestepping the possibility of equilibrium indeterminacy. This paper examines the source by estimating a medium-scale DSGE model using a Bayesian method that allows for indeterminacy. The estimated model shows that the Fed’s change from a passive to an active policy response to the inflation gap or a decrease in firms’ probability of price change can fully account for the decline in inflation gap persistence by ruling out indeterminacy that induces persistent dynamics of the economy.

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.


Suggested Citation

Hirose, Yasuo, Takushi Kurozumi, and Willem Van Zandweghe. 2021. “Inflation Gap Persistence, Indeterminacy, and Monetary Policy.” Federal Reserve Bank of Cleveland, Working Paper No. 21-05. https://doi.org/10.26509/frbc-wp-202105