The Output-gap, Nominal Wage and Consumer Price Inflation Volatility Trade-off

Abstract

We examine whether the policy-efficient frontier has shifted over time and show the periods associated with minimum inflation and output volatilities. Evidence shows that the output growth volatility tends to decline with varying magnitudes due to an unexpected positive consumer price inflation and nominal wage volatility shock. This trade-off is evident in the samples for pre- and post-inflation targeting framework although it is a time-varying process. There is a negative relationship (that is, the Taylor curve) between consumer inflation volatility, nominal wage volatility and output growth volatility. In addition, the results show that the effects of demand and supply shocks on consumer price inflation and output-gap volatilities are not persistent. The policy implication is that departures or deviations from the Taylor curve should be short-lived if the central bank operates efficiently.