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Endogenous Credibility and Wage-Price Spirals

Author

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  • Olena Kostyshyna
  • Tolga Özden
  • Yang Zhang

Abstract

Elevated inflation can threaten the credibility of central banks and increase the risk that inflation expectations do not remain anchored. Wage-price spirals might develop in such an environment, and high inflation could become entrenched. We quantitively assess the risks of a wage-price spiral occurring in Canada over history by using a medium-scale dynamic stochastic general equilibrium model enhanced with heterogenous expectation and learning. This mechanism generates time-varying propagation of inflationary shocks that improves forecasting performance of inflation and wage growth. Central bank credibility is endogenous in our model and depends on several notions of the learning mechanism. Weaker credibility and a higher risk of inflation expectations not remaining anchored increase the risk of a wage-price spiral.

Suggested Citation

  • Olena Kostyshyna & Tolga Özden & Yang Zhang, 2024. "Endogenous Credibility and Wage-Price Spirals," Staff Working Papers 24-14, Bank of Canada.
    • Handle: RePEc:bca:bocawp:24-14
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    More about this item

    Keywords

    Business fluctuations and cycles; Credibility; Inflation and prices; Monetary policy;
    All these keywords.

    JEL classification:

    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E7 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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