Trend Inflation and the Unemployment Volatility Puzzle

Abstract

I show that the combination of small positive trend inflation with staggered prices may account for the large relative volatilities found in US labor market data. The model does not have any wage rigidity and is hit only by an aggregate technology shock. The calibration procedure uses standard parameter values. Controlling for the sample average of the CPI inflation rate and the degree of price stickiness, the model solves the Shimer (2005) puzzle and explains the volatilities observed during two important sample periods: full sample (1951-2005) and Great Moderation (1985-2005).

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