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The Output Effect Of Stopping Inflation When Velocity Is Time Varying

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Author Info

  • Lynne Evans

    (Newcastle University Business School)

  • Anamaria Nicolae

    (Durham University Business School)

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    Abstract

    This paper explores the role of time varying velocity on output responses to policies for reducing/stopping inflation. We study a dynamic general equilibrium model with sticky prices in which we introduce time varying velocity. Specifically, nonstationary velocity is endogenised in the model developed by Ireland (1997) for analysing optimal disinflation. The non-linear solution method reveals that, depending on velocity, the ‘disinflationary boom’ found by Ball (1994) may disappear and that early output losses may be much larger than previously thought. Indeed, we find that a gradual disinflation from a low inflation may even be undesirable given its overall negative impact on the economy.

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    File URL: http://www.rebe.rau.ro/RePEc/rau/journl/SU08/REBE-SU08-A6.pdf
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    Bibliographic Info

    Article provided by Romanian-American University in its journal Romanian Economic and Business Review.

    Volume (Year): 3 (2008)
    Issue (Month): 2 (June)
    Pages: 60-77

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    Handle: RePEc:rau:journl:v:3:y:2008:i:2:p:60-77

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    Related research

    Keywords: price stability; velocity; disinflation; output boom; optimal speed of disinflation;

    References

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    1. Hodrick, Robert J & Kocherlakota, Narayana R & Lucas, Deborah, 1991. "The Variability of Velocity in Cash-in-Advance Models," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 358-84, April.
    2. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "Optimal monetary policy," Working Papers 01-5, Federal Reserve Bank of Philadelphia.
    3. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
    4. Peter N. Ireland, 1996. "Stopping inflations, big and small," Working Paper 96-01, Federal Reserve Bank of Richmond.
    5. Ball, Laurence & Mankiw, N Gregory, 1994. "Asymmetric Price Adjustment and Economic Fluctuations," Economic Journal, Royal Economic Society, vol. 104(423), pages 247-61, March.
    6. Mehra, Rajnish & Prescott, Edward C., 1988. "The equity risk premium: A solution?," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 133-136, July.
    7. Anamaria Nicolae & Charles Nolan, 2004. "The impact of imperfect credibility in a transition to price stability," Money Macro and Finance (MMF) Research Group Conference 2003 72, Money Macro and Finance Research Group.
    8. Rotemberg, Julio J & Woodford, Michael, 1992. "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity," Journal of Political Economy, University of Chicago Press, vol. 100(6), pages 1153-1207, December.
    9. Basu, Parantap & Dua, Pami, 1996. "The behavior of velocity and nominal interest rates in a cash-in-advance model," Journal of Macroeconomics, Elsevier, vol. 18(3), pages 463-478.
    10. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    11. Mehra, Rajnish, 1988. "On the Existence and Representation of Equilibrium in an Economy with Growth and Nonstationary Consumption," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(1), pages 131-35, February.
    12. Friedman, Benjamin M & Kuttner, Kenneth N, 1992. "Money, Income, Prices, and Interest Rates," American Economic Review, American Economic Association, vol. 82(3), pages 472-92, June.
    13. Burstein, Ariel T., 2006. "Inflation and output dynamics with state-dependent pricing decisions," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1235-1257, October.
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