We are grateful for helpful comments from Kosuke Aoki, Jim Bullard, Andrea Gerali, Seppo Honkapohja, Francesco Lippi, Tom Sargent, Peter Sinclair, Noah Williams, and two anonymous referees. Martin Ellison acknowledges support from the Bank of England and an ESRC Research Fellowship, “Improving Monetary Policy for Macroeconomic Stability in the 21st Century” (RES-000-27-0126). The views in this paper should not be taken to be those of either the Bank of England or the Monetary Policy Committee.
Escaping Volatile Inflation
Version of Record online: 8 JUN 2007
Journal of Money, Credit and Banking
Volume 39, Issue 4, pages 981–993, June 2007
How to Cite
ELLISON, M. and YATES, T. (2007), Escaping Volatile Inflation. Journal of Money, Credit and Banking, 39: 981–993. doi: 10.1111/j.1538-4616.2007.00054.x
- Issue online: 8 JUN 2007
- Version of Record online: 8 JUN 2007
- Received October 12, 2004; and accepted in revised form September 5, 2006.
- escape dynamics;
- monetary policy
Why has inflation been so stable in developed economies since the early 1990s? In this paper, we answer that the United States and other countries may have escaped from a volatile inflation equilibrium. Our argument builds on the story proposed by Tom Sargent in The Conquest of American Inflation, where the fall in inflation in the 1980s was attributed to changing government beliefs. To explain the escape in inflation volatility, we unwind one of Sargent's simplifications and allow the government to react to some of the shocks in the economy. In this case, when government beliefs turned against the Phillips curve in the 1980s they not only led to an escape from high inflation, but also stopped government using changes in inflation to offset shocks. Inflation and inflation volatility therefore escaped in tandem. Our analysis also sheds some light on why the escape in inflation occurred at the time it did.