International Finance Discussion Papers (IFDP)
August 2002
The Inflation Persistence of Staggered Contracts
Abstract:
One of the criticisms routinely advanced against models of the business cycle with staggered contracts is their inability to generate inflation persistence. This paper finds that staggered Taylor contracts are, in fact, capable of reproducing the inflation persistence implied by U.S. data. Following Fuhrer and Moore, I capture the moments that the contract specification needs to replicate by using the correlograms from a small vector autoregression (VAR) that includes inflation among the endogenous variables. A simple structural model substitutes the inflation equation from the VAR with the contract specification. I estimate the contract parameters in the structural model by maximum likelihood. The correlogram for the endogenous variables from the estimated structural model, including that for inflation, are very close to the correlograms from the VAR (and are contained within their 90% confidence intervals). By the same metric, where Taylor contracts do not fare well is in reproducing the cross-correlations between inflation and output.
Keywords: Maximum likelihood, Phillips curve
PDF: Full Paper
Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.