Inflation Inertia and Monetary Policy Shocks

This paper compares the New Keynesian Phillips curve with the hybrid Phillips curve for its ability to reproduce observed in.ation and output dynamics. The analysis is based on impulse responses of a miniature general equilibrium model incorporating price and in.ation inertia as the only friction. Impulse responses to a monetary policy shock for di.erent intesities of inertia are compared with empirical impulse responses of the US economy estimated using a structural VAR. We .nd that the NKPC does a reasonably good job of reproducing the dynamic link between current output and future inflation. It fails however to reproduce the co-movement of current output with current and lagged in.ation and it generates too low degrees of inflation and output persistence. The assumption of inflation inertia improves a model?s performance of reproducing inflation persistence and the dynamic inflation-output link. A significant improvement requires high intensity of inflation inertia. The fit of observed output persistence can not be improved.