Abstract

Inflation volatility has significantly declined over the last 20 years in the U.S. To find out why, I follow a structural approach. I estimate a complete New Keynesian model that imposes cross-equation restrictions on the time series of inflation, the output gap and the interest rate. I perform the analysis with three measures of inflation: Consumer Price Index (CPI), Gross Domestic Product Deflator (GDPD) and Personal Consumption Expenditure Deflator (PCE). While CPI and PCE inflation volatility fell because the internal propagation mechanism changed, GDPD inflation volatility decreased because of the smaller shocks. The shift towards a more aggressive monetary policy can explain a large percentage of the decrease in CPI and PCE inflation volatility.

Citations