Inflation Dynamics When Inflation Is Near Zero

• Published in: Journal of money, credit and banking Vol. 44; no. s1; pp. 83 - 122
• Main Authors: FUHRER, JEFFREY C., OLIVEI, GIOVANNI P., TOOTELL, GEOFFREY M. B.
• Format: Journal Article
• Language: English
• Published: Malden, USA Blackwell Publishing Inc 01.02.2012; Wiley Subscription Services; Wiley-Blackwell; Ohio State University Press
• Subjects: 1954-2012; anchored expectations; Bank credit; Coefficients; Comparative economics; Core inflation; Credit; Cross-national analysis; downward nominal wage rigidity; E12; E31; E52; Economic models; Historical analysis; Inflation; Inflation rates; Inflationserwartung; Japan; Lohnrigidität; Marginal costs; Nominal rigidities; Nominal wages; Output gaps; Phillips curve; Prices; Studies; survey expectations; U.S.A; USA; Wage rates; Wage rigidity; Wages; Wages & salaries; Zins; United States > US; Japan
• ISSN: 0022-2879; 1538-4616
• DOI: 10.1111/j.1538-4616.2011.00479.x

We discuss the likely evolution of U.S. inflation in the near and medium terms on the basis of (i) past U.S. experience with very low levels of inflation, (ii) the most recent Japanese experience with negative inflation, and (iii) some preliminary U.S. micro evidence on downward nominal wage rigidity. Our findings question the view that stable long-run inflation expectations and downward nominal wage rigidity will necessarily provide sufficient support to prices to avoid further declines in inflation. We show that an inflation model fitted on Japanese data over the past 20 years, which accounts for both short-and long-run inflation expectations, matches the recent U.S. inflation experience quite well. While the model indicates that U.S. inflation might be subject to a lower bound, it does not rule out a prolonged period of low inflation or even mild deflation going forward. In addition, micro-level data on wages suggest no obvious downward rigidity in the firm's wage bill, downward rigidity in individual wages notwithstanding. As a consequence, downward nominal wage rigidity may not be enough to offset deflationary pressures in the current situation.