Intrinsic inflation persistence

Empirical evidence suggests that inflation determination is not purely forward-looking, but models of price setting have struggled to rationalize this finding without directly assuming backward-looking pricing rules for firms. This paper shows that intrinsic inflation persistence can be explained with no deviation from optimizing, forward-looking behaviour if prices that have remained fixed for longer are more likely to be changed than those set recently. A relationship between the probability of price adjustment and the duration of a price spell is shown to imply a simple “hybrid” Phillips curve including lagged and expected inflation, which is estimated using macroeconomic data.

Research Highlights► Inflation not purely forward-looking with non-random selection of adjusted prices. ► If more likely to change older prices then intrinsic inflation persistence present. ► Simpler “hybrid” Phillips curves can be derived for a general hazard function. ► Macro-data estimate of hazard function suggests it is largely upward sloping.