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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Inflation Persistence and Relative Contracting
John C. Driscoll and Steinar Holden

Abstract: Macroeconomists have for some time been aware that the New Keynesian Phillips curve, though highly popular in the literature, cannot explain the persistence observed in actual inflation. We argue that one of the more prominent alternative formulations, the Fuhrer and Moore (1995) relative contracting model, is highly problematic. Fuhrer and Moore's 1995 formulation generates inflation persistence, but this is a consequence of their assuming that workers care about the past real wages of other workers. Making the more reasonable assumption that workers care about the current real wages of other workers, one obtains the standard formulation with no inflation persistence.

Keywords: Inflation persistence

Full paper (268 KB PDF)

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Last update: August 5, 2003