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Designing linear inflation contracts in the New Keynesian model

Author

Listed:
  • Meixing Dai

    (BETA, University of Strasbourg, France)

  • Marine Charlotte André

    (Université de Strasbourg, Université de Lorraine, CNRS, BETA, 67000 Strasbourg, France.)

Abstract

This paper studies how to design linear inflation contracts to shape the incentive structure faced by the central bank in the New Keynesian model with positive optimal output gap and inflation target. Such contracts are known to be able to deal with the time-inconsistency problem in the Barro-Gordon framework, arising from incentives for the central bank to exploit the inflation-output trade-off induced by an “overambitious” output-gap target. We show that linear inflation contracts help reduce inflation undershooting and partially eliminate the inflation bias in the New Keynesian model. They are significantly different from those designed in the Barro-Gordon model.

Suggested Citation

  • Meixing Dai & Marine Charlotte André, 2022. "Designing linear inflation contracts in the New Keynesian model," Economics Bulletin, AccessEcon, vol. 42(4), pages 1782-1797.
    • Handle: RePEc:ebl:ecbull:eb-22-00627
    as

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    References listed on IDEAS

    as
    1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    2. Dai, Meixing & Spyromitros, Eleftherios, 2012. "Inflation contract, central bank transparency and model uncertainty," Economic Modelling, Elsevier, vol. 29(6), pages 2371-2381.
    3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    4. Walsh, Carl E, 2003. "Accountability, Transparency, and Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(5), pages 829-849, October.
    5. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    inflation bias; inflation contract; monetary policy delegation; optimal monetary policy;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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