On Inflation and the Persistence of Shocks to Output

This paper empirically investigates the possibility that the effects of shocks to output depend on the level of inflation. The analysis extends Elwood’s (1998) framework by incorporating in the model an inflation-threshold process that can potentially influence the stochastic properties of output. The value of this threshold parameter, if it exists, is considered to be unknown and is estimated in the model. The results indicate that shocks to output indeed have asymmetric effects, depending on the level of inflation: negative shocks are more detrimental when inflation is high, and positive shocks are more persistent when inflation is low.