The lower inflation, in turn, restrains nominal wage demands, contributing for a time to a virtuous cycle of lower wage change and price inflation. In the appendix, I present a simple model that incorporates this asymmetric response. The demand and direct disinflationary effects have conflicting implications for inflation.
The abovetrend growth associated with the demand effect lowers the unemployment rate, and the tighter labor market puts upward pressure on inflation. The direct disinflationary effect, on the other hand, lowers inflation for any given unemployment rate.