Do Positive Nominal Volatility Shocks Reduce the Output-Inflation Trade-Off and Is There a Role for Inflation Regimes?

Abstract

The chapter determines the extent to which elevated nominal volatilities make expansionary policy ineffective in achieving maximum real output and low inflation. Evidence shows that elevated nominal demand and inflation volatility shocks reduce the output-inflation trade-off and this reduces policy effectiveness in achieving desirable outcomes. The magnitudes of the reduction in the output-inflation trade-off effects are larger in the high inflation regime than in the low regime. In addition, a combination of increases in both inflation and nominal demand volatilities is bad for the output-inflation trade-off. Therefore, policymakers should minimize these volatilities when implementing demand policies and ensure that price stability is enforced to minimize inflation volatility.