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Perry, Nathan
Cline, Nathaniel
Year of Publication: 
Series/Report no.: 
Working Paper No. 759
Several explanations of the great inflation moderation (1982-2006) have been put forth, the most popular being that inflation was tamed due to good monetary policy, good luck (exogenous shocks such as oil prices), or structural changes such as inventory management techniques. Drawing from Post-Keynesian and structuralist theories of inflation, this paper uses a vector autoregression with a Post-Keynesian identification strategy to show that the decline in the inflation rate and inflation volatility was due primarily to (1) wage declines and (2) falling import prices caused by international competition and exchange rate effects. The paper uses a graphical analysis, impulse response functions, and variance decompositions to support the argument that the decline in inflation has in fact been a wage and import price moderation, brought about by declining union membership and international competition. Exchange rate effects have lowered inflation through cheaper import and oil prices, and have indirectly affected wages through strong dollar policy, which has lowered manufacturing wages due to increased competition. A Taylor rule differential variable was also used to test the good policy hypothesis. The results show that the Taylor rule differential has a smaller effect on inflation, controlling for other factors.
Taylor rule
Document Type: 
Working Paper

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