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No Pain, No Gain? The Simple Analytics of Efficient Disinflation in Open Economies

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  • Buiter, Willem H
  • Grafe, Clemens

Abstract

The Paper studies the design of efficient disinflation programmes in open economies using the sacrifice ratio; that is, the cumulative additional un-employment or cumulative lost output required to achieve a 1% sustained reduction in the rate of inflation, as the metric of efficiency. The ’new Keynesian’ Phillips curve first proposed by Calvo has a zero sacrifice ratio: costless disinflation is possible, because the inflation process is purely forward-looking. There is inertia or rigidity in the price level but not in the rate of inflation. More interesting inflation kernels for which current inflation is partly forward-looking and partly backward-looking have a positive sacrifice ratio. Real exchange rate appreciation early in the disinflation process may raise the sacrifice ratio relative to a policy that keeps the real exchange rate constant. The sacrifice ratio is lower under gradualism than under ’cold turkey’. Effficient disinflation policies may, however, be time-inconsistent and therefore not credible.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3038.

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Date of creation: Nov 2001
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Handle: RePEc:cpr:ceprdp:3038

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Related research

Keywords: disinflation; new Keynesian Phillips curve; sacrifice ratio;

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References

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  1. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  2. Gregory, R G, 1986. "Wages Policy and Unemployment in Australia," Economica, London School of Economics and Political Science, vol. 53(210(S)), pages S53-74, Supplemen.
  3. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Finance and Economics Discussion Series 93-17, Board of Governors of the Federal Reserve System (U.S.).
  4. repec:nbr:nberre:0126 is not listed on IDEAS
  5. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  6. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters, in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
  7. John B. Taylor, 1998. "Staggered Price and Wage Setting in Macroeconomics," NBER Working Papers 6754, National Bureau of Economic Research, Inc.
  8. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Working Papers 1950, National Bureau of Economic Research, Inc.
  9. N. Gregory Mankiw, 2000. "The Inexorable and Mysterious Tradeoff Between Inflation and Unemployment," Harvard Institute of Economic Research Working Papers 1905, Harvard - Institute of Economic Research.
  10. Laurence Ball & N. Gregory Mankiw & David Romer, 1988. "The New Keynsesian Economics and the Output-Inflation Trade-off," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 1-82.
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Cited by:
  1. Gaston Gelos & Alessandro Prati & Oya Celasun, 2004. "Obstacles to Disinflation," IMF Working Papers 04/111, International Monetary Fund.
  2. Tödter, Karl-Heinz, 2002. "Monetary indicators and policy rules in the P-star model," Discussion Paper Series 1: Economic Studies 2002,18, Deutsche Bundesbank, Research Centre.
  3. António Duarte, 2009. "The Portuguese Disinflation Process: Analysis of Some Costs and Benefits," Transition Studies Review, Springer, vol. 16(1), pages 157-173, May.
  4. Gaston Gelos & Alessandro Prati & Oya Celasun, 2003. "Would "Cold Turkey" Work in Turkey?," IMF Working Papers 03/49, International Monetary Fund.

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