High Inflation Dynamics: Integrating Short-Run Accommodation and Long-Run Steady-States
The paper develops a model for the analysis of high inflation phenomena. A central feature in of the model is the joint determination of the long-run steady-state rate of inflation and of the short-run dynamic process of inflation. The model includes a formal structure that is based on a simple, but powerful theorem: for a non-stationary (unit-root) inflationary process a price level shock eventually translates into a higher steady state rate of inflation which equals the ratio of the shock to the mean lag of inflation. The econometric approach is based on the apparent non-stationary behavior of the rates of change of the nominal variables in high inflation countries (prices, wages, exchange-rate and money). An application for the inflationary process in Israel during 1964-1993 is presented.