Correlated shocks, hysteresis, and the sacrifice ratio: Evidence from India

Ashima Goyal and Gagan Goel ()
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Gagan Goel: Indira Gandhi Institute of Development Research

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: In an emerging market subject to frequent shocks output sacrifice from disinflation depends not only on the Phillips curve slope but also on shifts in demand and supply. Introducing shocks and correlations between shocks in a Kalman filter based estimation, the slope flattens, correlation between permanent output shocks (supply) and output gap (demand) shocks is negative and a new decomposition of output between trend and output gap shocks is obtained. The flat supply curve is robust to parameter changes, and business cycle turning points are tracked well, but the decomposition varies. More stable inflation expectation and rise in forward-looking behaviour increases volatility of trend growth and reduces the output gap. Inflation targeting had such effects in India. Estimated sacrifice ratio varies with the period and method, but it rises to 6.7 over 2011-17 if such hysteresis is included. Simultaneous equation estimation corroborates the results. In the estimation period, inflation targeting affected expectations but not inflation.

Keywords: Sacrifice ratio; Phillips curve slope; correlated demand and supply shocks; hysteresis (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2019-08
New Economics Papers: this item is included in nep-mac
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Journal Article: Correlated Shocks, Hysteresis, and the Sacrifice Ratio: Evidence from India (2021)
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