Output gains from accelerating core inflation

Abstract

Previous research finds that the analysis of sacrifice ratios–namely, identifying disinflation episodes, calculating the sacrifice ratio, and looking at its determinants–changes substantially when one moves from headline to core inflation. This paper examines whether similar findings are obtained when examining benefice ratios, and we find arguably even greater differences. Specifically, we see that headline inflation identifies far more inflationary episodes since the 1990s than core inflation does. Furthermore, Jordan’s (1997) argument that the speed of inflation is a negative and significant determinant of benefice ratios does not hold when we move from headline to core inflation, both within the U.S. and also across the OECD. We also find strong evidence that the initial level of GDP at the onset of an inflationary episode matters. In particular, output gains from accelerating inflation appear only to be beneficial for OECD countries that start with a low level of GDP. Conversely, countries that start with a high level of GDP should not pursue additional output gains from allowing a rise in inflation.