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Trend Inflation, Wage and Price Rigidities, and Welfare

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Author Info
Robert Amano
Kevin Moran
Stephen Murchison
Andrew Rennison

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Abstract

This paper studies the steady-state costs of inflation in a general-equilibrium model with real per capita output growth and staggered nominal price and wage contracts. Our analysis shows that trend inflation has important effects on the economy when combined with nominal contracts and real output growth. Steady-state output and welfare losses are quantitatively important even for low values of trend inflation. Further, we show that nominal wage contracting is quantitatively more important than nominal price contracting in generating these losses. This important result does not arise from price dispersion per se but from an effect of nominal output growth on the optimal markup of monopolistically competitive labour suppliers. We also demonstrate that accounting for productivity growth is important for calculating the welfare costs of inflation. Indeed, the presence of two percent productivity growth increases the welfare costs of inflation in our benchmark specification by a factor of four relative to the nogrowth case.

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File URL: http://www.bankofcanada.ca/en/res/wp/2007/wp07-42.pdf
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Paper provided by Bank of Canada in its series Working Papers with number 07-42.

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Length: 32 pages
Date of creation: 2007
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Handle: RePEc:bca:bocawp:07-42

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Related research
Keywords: Inflation: costs and benefits;

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Find related papers by JEL classification:
E0 - Macroeconomics and Monetary Economics - - General
E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
    Other versions:
  2. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 249-83, April.
    Other versions:
  3. Taylor, John B., 1999. "Staggered price and wage setting in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 15, pages 1009-1050 Elsevier. [Downloadable!] (restricted)
    Other versions:
  4. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia. [Downloadable!]
    Other versions:
  5. Robert G. King & Alexander L. Wolman, 1996. "Inflation Targeting in a St. Louis Model of the 21st Century," NBER Working Papers 5507, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Guido Ascari, 2004. "Staggered prices and trend inflation: some nuisances," Macroeconomics 0404029, EconWPA. [Downloadable!]
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  7. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October. [Downloadable!] (restricted)
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  8. Andreas Hornstein & Alexander L. Wolman, 2005. "Trend inflation, firm-specific capital, and sticky prices," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 57-83. [Downloadable!]
  9. Liam Graham & Dennis J. Snower, 2004. "The real effects of money growth in dynamic general equilibrium," Working Paper Series 412, European Central Bank. [Downloadable!]
  10. Alexander L. Wolman, 2009. "The optimal rate of inflation with trending relative prices," Working Paper 09-02, Federal Reserve Bank of Richmond. [Downloadable!]
  11. Ascari, Guido, 1998. "Superneutrality Of Money In Staggered Wage-Setting Models," Macroeconomic Dynamics, Cambridge University Press, vol. 2(03), pages 383-400, September. [Downloadable!]
  12. Alexander L. Wolman, 2001. "A primer on optimal monetary policy with staggered price-setting," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 27-52. [Downloadable!]
  13. repec:cup:macdyn:v:2:y:1998:i:3:p:383-400 is not listed on IDEAS
  14. Huang, Kevin X. D. & Liu, Zheng, 2002. "Staggered price-setting, staggered wage-setting, and business cycle persistence," Journal of Monetary Economics, Elsevier, vol. 49(2), pages 405-433, March. [Downloadable!] (restricted)
    Other versions:
  15. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
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  16. Basu, Susanto, 1996. "Procyclical Productivity: Increasing Returns or Cyclical Utilization?," The Quarterly Journal of Economics, MIT Press, vol. 111(3), pages 719-51, August. [Downloadable!] (restricted)
    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Yilmazkuday, Hakan, 2009. "Is there a Role for International Trade Costs in Explaining the Central Bank Behavior?," MPRA Paper 15951, University Library of Munich, Germany. [Downloadable!]
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