Working Paper Series no. 190: The Dynamic Effects of Disinflation Policies.

Abstract

This paper investigates the effects of disinflation policies on key macroeconomic variables. Using postwar US data and episode techniques, we identify disinflation shocks as shocks that drive the inflation rate to a lower level in the long-run. We find that in the immediate aftermath of a disinflation policy, the economy enters in a persistent recession. The inflation rate increases above its long-run level and exhibits a positive hump-shaped response. A similar pattern is found for the nominal interest rate, which responds even more strongly in the short-run. We then show that the standard new Keynesian model fails to account for macroeconomic dynamics in disinflationary times. On the contrary a deep habit version of the model successfully accounts for the effects of disinflation policies.

Fabrice Collard, Patrick Fève and Julien Matheron
November 2007

Classification JEL : E31, E32, E52.

Keywords : Disinflation policies, Deep Habits, New Keynesian Models.