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1. Introduction
One of the most important characteristics of the dynamics of inflation is its persistence. Policy makers view inflation persistence with great interest because of its central role in determining how monetary policy responds to shocks over time (see, e.g. Gerlach and Tillmann, 2012; van der Cruijsen et al., 2010). Persistence measures the speed at which shocks to inflation die out and the inflation rate returns to its target or its mean. With high inflation persistence, shocks to inflation exert long-lasting effects and may require a strong policy response to bring inflation under control. In the worst case, inflation may contain a unit root, which could lead to unpalatable choices for monetary policy, since inflation randomly drifts away in any direction, making it difficult for the monetary authorities to control inflation. In the best case, inflation may prove stationary, implying that it reverts to its initial level rapidly after a shock occurs. One area of the literature on inflation persistence considers whether shocks to the inflation process decay rapidly, as with nonintegrated processes, or whether they decay much more slowly, as with fractionally integrated processes. In the latter case, inflation rates display evidence of persistence or long memory[1].
New-Keynesian dynamic stochastic general equilibrium macroeconomic models that incorporate lags of inflation in the new-Keynesian Phillips curve[2] identify inflationary expectations as the main determinant of inflation persistence, suggesting that the decline in inflation persistence may occur through enhanced anchoring of inflation expectations (Mishkin, 2007; Nautz and Strohsal, 2015). That is, a monetary policy that successfully anchors inflationary expectations reduces or eliminates inflation persistence, since well-anchored inflationary expectations are much less dependent on past inflation. That is, if the central bank announces that it will keep inflation at 2 percent over the medium to long run, and economic agents believe it, then inflation expectations should equal exactly 2 percent[3]. Unlike monetary targeting, the inflation targeting (IT) framework does not depend on the stability of the demand for money and, unlike foreign exchange targeting, does not require changes in interest rates, direct foreign exchange intervention, and the loss of independent monetary policy (Mishkin, 1998). The linkage between monetary policy and the stability of the demand for money, however, remains after the switch to IT. Thus, the debate...