From the comments, Ano writes:
I think an additional factor contributing to the “why is there 1.6% inflation” question is the following: The “right” wage offer for each individual worker varies from worker to worker. The distribution of wage offers gets trimmed at zero. So even a distribution that would have a mean below zero in a non-rigidity world can have a positive mean if the distribution gets trimmed at zero. It’s another zero lower bound at work in the labor market!
There is a related Paul Krugman blog post here.
I have several worries about this approach, but my biggest one is this. Even with truncation, where are so many inflationary pressures coming from in the first place? Let’s say for instance (to make it easy) that half of the economy is subject to (stifled and truncated to zero) deflationary pressures, and the other half is subject to (non-stifled) inflationary pressures of 3.2%. To make this easy to talk about, imagine those halves average out to 1.6% inflation.
What does it say about your economy — vis-a-vis the all-important business cycle fact of comovement — if half of the sectors are seeing inflationary pressure at 3.2%?
One option is that those sectors are the victim of negative supply shocks. I am comfortable with a comparable conclusion, namely that both AD and AS shocks have been important in a variety of recent economic downturns, although I would not use this chain of reasoning to get there.
Another option is that these non-stifled sectors have seen big boosts in demand and thus their prices are rising. Again, that violates the strong empirical regularity of business cycle comovement. In a traditional deflationary downturn, virtually all sectors are negatively affected, with a few notable exceptions. What kind of business cycle would this be, if half the economy is seeing a positive 3.2% worth of demand-side pressures?
Of course the number 3.2%, the division of the economy into halves, and the like are artifacts, to make this easy to discuss on a blog. But to the extent you make the non-stifled sector of the economy smaller, the shocks hitting it have to be larger, and so on, so that is no easy way out of the basic dilemma.
1. CPI annual inflation stands at 2.9% in June.
2. Core inflation stands at 2.3% and has not been below 2% in some time.
3. The producer price index is showing 4.2% inflation (see the first link).
Is that being driven by the zero point truncation of nominal wages? I don’t think so. By the way, that is about as a clear of a refutation of liquidity trap models as one could expect to find.
Addendum: Arnold Kling offers comment.