Modeling Inflation Dynamics: A Critical Review of Recent Research

Authors


  • A more complete version of this paper (Rudd and Whelan 2005c) was presented at the FRB/JMCB conference “Quantitative Evidence on Price Determination.” We are grateful to our conference discussants, Laurence Ball and Bennett McCallum, and to two anonymous referees for a number of helpful comments. The views expressed are our own and do not necessarily reflect the views of the Board of Governors, the staff of the Federal Reserve System, or the Central Bank of Ireland.

Abstract

In recent years, a broad academic consensus has arisen that favors using rational expectations sticky-price models to capture inflation dynamics. We review the principal conclusions of this literature concerning: (1) the ability of these models to fit the data; (2) the importance of rational forward-looking expectations in price setting; and (3) the appropriate measure of inflationary pressures. We argue that existing models fail to provide a useful empirical description of the inflation process.

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