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Disinflation effects in a medium-scale New Keynesian model: Money supply rule versus interest rate rule

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  • Ascari, Guido
  • Ropele, Tiziano

Abstract

Empirical studies show that successful disinflations entail a period of output contraction. Using a medium-scale New Keynesian model, we compare the effects of disinflations of different speed and timing, implemented through either a money supply rule or an interest rate rule. In terms of transitional output loss, cold-turkey disinflations under an interest rate rule are less costly than those under a money supply rule and are accomplished more rapidly. Furthermore, gradual or anticipated disinflations deliver lower sacrifice ratios. From a welfare perspective, despite the temporary economic contraction, the transitional welfare loss is quantitatively negligible, so that disinflations are overall welfare-improving. The overall welfare gain is not affected by how the disinflation is actually implemented: what really matters is the achievement of a permanently lower inflation rate.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 61 (2013)
Issue (Month): C ()
Pages: 77-100

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Handle: RePEc:eee:eecrev:v:61:y:2013:i:c:p:77-100

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Web page: http://www.elsevier.com/locate/eer

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Keywords: Disinflation; Sacrifice ratio; Welfare;

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