An economic paper on inflation and output gaps

This working paper from the IMF, not yet official.

And this chart taken by Davies in his summary

What happens to inflation during a prolonged recession?  Well, let's skip the New Keynesian Expectation thing and just ask what the economy is going according to an orthogonalization process.

When an economy hits a constraint, it reduces the dimensionality of production, until the most constrained input is no longer constrained.  It is the most constrained resource that contracts first, contracting until all inventory levels are back within the biologically determined variance/level (1/SNR).  Other production networks will contract depending upon their correlation with the constrained resource.  We can see right away that their are common denominator issues, some networks need not completely contract, but merely may set aside savings accounts as place holders. This is the Ramsey Subgraph process.

Stochastic processes (variance optimization) takes place within the resulting "corridor".   Yhe corridors set up as Shannon channels.

All inventories increase during the contraction, causing inventory levels to rise relative to inventory variances (making prices appear to deflate).    Once the economy is arranged about  most constrained input, the economy then works  like a Bellman optimization.

There is an economist named Will Smith around somewhere that worked this stuff out, go locate his paper.

Where are the expectations of the agent? Well, agents expect to solve the damn problem or go broke, frankly.

Economies that already suffer some inflation prior to the recession, are already partially constrained, so they do not have far to contract before they find the recession causing constraint.  It is a search process.

What is the point?  Inflation/deflation in prices is an artifact of changing inventory variances as the stages of production reduce with a fixed amount of goods, inventories have to rise and prices (inventory variance/inventory level) must drop.

In QM Theory the key to the analysis is that the production structure being a Shannon channel will split the Yields curves such that each level of the deflation should split the N stages of production evenly along the curve according to Power Spectrum.  So, we should know what the yield curves look like at each point in the deflation., and under mild assumptions be able to compute the relative changes in inventory variances at each contraction level.

The other take away is that there is no such thing as inflation anchoring, there is equilibrium at which point all agents measure the same constant signal to noise level in inventories.

What about the differing adaption rates between lightweight and heavy weight goods? More later.