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What Drives Low and Stable Inflation?

Author

Listed:
  • Joshua Brault

    (Bank of Canada)

  • Louis Phaneuf

    (University of Quebec in Montreal)

Abstract

We answer this question by estimating New Keynesian (NK) models with positive trend inflation using Bayesian methods. The models estimated differ by the degree of interest-rate smoothing, measures of the inflation gap and economic activity the Fed targets in setting the policy rate, and the persistence (or lack thereof) of monetary policy shocks. We use time-series covering three different inflationary periods ranging in the US from 1964 to 2022. Our evidence indicates that inflation stability did not likely result from a much stronger Fed's response to the inflation gap. It points instead to a moderate increase in the Fed's response, combined predominantly with smaller movements in the inflation target. We identify second-order interest-rate smoothing, a time-varying inflation target, a policy response to output growth, and mildly persistent monetary policy shocks as important factors driving our findings.

Suggested Citation

  • Joshua Brault & Louis Phaneuf, 2025. "What Drives Low and Stable Inflation?," Working Papers 25-02, Chair in macroeconomics and forecasting, University of Quebec in Montreal's School of Management, revised Feb 2025.
    • Handle: RePEc:bbh:wpaper:25-02
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    More about this item

    Keywords

    Bayesian estimation; Taylor rules; second-order interest-smoothing; time-varying target inflation; output growth targeting; persistent policy shocks; determinacy;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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