Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/336008 
Authors: 
Year of Publication: 
2025
Series/Report no.: 
CESifo Working Paper No. 12306
Publisher: 
Munich Society for the Promotion of Economic Research - CESifo GmbH, Munich
Abstract: 
I identify the natural rate of inflation: the threshold where signal-to-noise crosses unity. Extending Lucas (1972), I show that when inflation falls below sectoral volatility, firms cannot distinguish aggregate from idiosyncratic shocks. Sticky-price firms rationally filter out competitor price movements, creating endogenous stability. When inflation exceeds the natural rate, filtering ceases, coordination increases, and inflation becomes self-reinforcing. Using six million UK micro-price observations, I estimatethis threshold at 1.9%. Crossing it triggers a regime shift: price dispersion falls 10%, inflation persistence jumps from near-zero to 0.44, and monetary policy loses traction. These findings validate 2% targets as the limit of self-correction.
Subjects: 
inflation targeting
strategic pricing
behavioural thresholds
sectoral volatility
monetary policy
price complementarity
JEL: 
E31
E52
E58
D21
L13
Document Type: 
Working Paper
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