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Calvo Contracts - Optimal Indexation in General Equilibrium

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  • Le, Vo Phuong Mai

    ()
    (Cardiff Business School)

  • Minford, Patrick

    ()
    (Cardiff Business School)

Abstract

Calvo contracts, which are the basis of the current generation of New Keynesian models, widely include indexation to general inflation. We argue that the indexing formula should be expected inflation rather than lagged inflation. This is likely to optimise the welfare of the representative agent in a general equilibrium model of the New Keynesian type. The economy's behaviour under rational indexation is similar to that of a New Classical model, with shocks producing an immediate fluctuation in both prices and output followed by a fairly rapid return to steady state. A monetary policy that targets the price level increases economic stability.

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Bibliographic Info

Paper provided by Cardiff University, Cardiff Business School, Economics Section in its series Cardiff Economics Working Papers with number E2007/8.

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Length: 38 pages
Date of creation: Mar 2007
Date of revision: Oct 2008
Handle: RePEc:cdf:wpaper:2007/8

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Keywords: Calvo contracts; general equilibrium; rational indexation;

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Cited by:
  1. Le, Vo Phuong Mai & Minford, Patrick, 2007. "Optimising indexation arrangements under Calvo contracts and their implications for monetary policy," Cardiff Economics Working Papers E2007/7, Cardiff University, Cardiff Business School, Economics Section.

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