Asymmetric Effects of Economic Activityon Inflation: Evidence and Policy Implications

Abstract

Data for the G-7 countries strongly support the view that economic activity has a nonlinear effect on inflation, with high levels of activity raising inflation by more than low levels decrease it. In the face of such asym- metries, the average level of output in an economy subject to demand shocks will be below the level of output at which there is no tendency for inflation to rise or fall, contrary to linear model predictions. One implication is that policymakers can raise the average level of output over time by responding promptly to demand shocks, reducing the variance of output around trend.