Understanding Post-COVID Inflation Dynamics

Download or read book Understanding Post-COVID Inflation Dynamics written by Martin Harding and published by International Monetary Fund. This book was released on 2023-01-20 with total page 42 pages. Available in PDF, EPUB and Kindle. Book excerpt: We propose a macroeconomic model with a nonlinear Phillips curve that has a flat slope when inflationary pressures are subdued and steepens when inflationary pressures are elevated. The nonlinear Phillips curve in our model arises due to a quasi-kinked demand schedule for goods produced by firms. Our model can jointly account for the modest decline in inflation during the Great Recession and the surge in inflation during the Post-Covid period. Because our model implies a stronger transmission of shocks when inflation is high, it generates conditional heteroskedasticity in inflation and inflation risk. Hence, our model can generate more sizeable inflation surges due to cost-push and demand shocks than a standard linearized model. Finally, our model implies that the central bank faces a more severe trade-off between inflation and output stabilization when inflation is high.