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The Impact of Trend Inflation in an Open Economy Model

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  • Emilio Fernandez-Corugedo
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    Abstract

    Most New Keynesian models are derived under the assumption that inflation is equal to zero in the steady-state and yet most central banks around the world have inflation targets that are greater than such a number. In this paper we consider the open economy (welfare) implications of non-zero steady-state inflation rates both in the domestic and foreign economies. We show that higher inflation rates in the steady-state, both in the domestic and foreign economies, reduce welfare in the domestic economy. We also show that high domestic inflation rates in the steady-state have a more adverse effect on domestic welfare than high foreign inflation rates.

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    File URL: http://www.banxico.org.mx/publicaciones-y-discursos/publicaciones/documentos-de-investigacion/banxico/%7B35F44A59-DE16-8EE6-EE64-2EC08E0FB346%7D.pdf
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    Bibliographic Info

    Paper provided by Banco de México in its series Working Papers with number 2007-15.

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    Date of creation: Dec 2007
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    Handle: RePEc:bdm:wpaper:2007-15

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    Web page: http://www.banxico.org.mx
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    Related research

    Keywords: Optimal Monetary Policy; Trend Inflation; Open Economy Macroeconomics;

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    1. Bennett T. McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," NBER Working Papers 8175, National Bureau of Economic Research, Inc.
    2. Guido Ascari, 2004. "Staggered Prices and Trend Inflation: Some Nuisances," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 642-667, July.
    3. Clarida, Richard & Gali, Jordi & Gertler, Mark, 2002. "A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(5), pages 879-904, July.
    4. Currie,David & Levine,Paul, 2009. "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521104609.
    5. Michael T. Kiley, 2004. "Is moderate-to-high inflation inherently unstable?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2004-43, Board of Governors of the Federal Reserve System (U.S.).
    6. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare And Macroeconomic Interdependence," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 116(2), pages 421-445, May.
    7. 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.
    8. Kiley, Michael T, 2000. "Endogenous Price Stickiness and Business Cycle Persistence," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 32(1), pages 28-53, February.
    9. repec:sae:niesru:v:164:y::i:1:p:100-109 is not listed on IDEAS
    10. Nelson, Edward, 2002. "Comment on: A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(5), pages 905-912, July.
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