IMF Working Papers

Understanding Post-COVID Inflation Dynamics

Author/Editor:

Martin Harding ; Jesper Lindé ; Mathias Trabandt

Publication Date:

January 20, 2023

Electronic Access:

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Summary:

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.

Series:

Working Paper No. 2023/010

Subject:

Central bank policy rate Demand elasticity Economic theory Financial services Inflation Interest rate floor Monetary policy Output gap Prices Production

Frequency:

regular