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The Case for Inflation Stability

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  • Collard, Fabrice
  • Dellas, Harris

Abstract

We evaluate the case for perfect price (inflation) stabilization in a New Keynesian (NNS) model that includes capital accumulation, a variety of shocks, a monetary and an imperfect competition distortion. In such a model, price rigidity may provide the monetary authorities with an opportunity to improve upon the inefficient flexible price equilibrium via the suitable cyclical manipulation of real marginal costs. We find that such an opportunity is of limited value. With only the imperfect competition friction present (in the ‘cashless’ version of the model), inflation variability is costly independent of the level of capital adjustment costs, the degree of price rigidity, the size of mark-ups, the degree of risk aversion and the type of the shock. A small amount of inflation variability may become desirable when prices are fairly flexible and capital adjustment costs low if the model includes both frictions.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4082.

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Date of creation: Oct 2003
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Handle: RePEc:cpr:ceprdp:4082

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Keywords: distortions; inflation stabilization; investment; price rigidity;

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  1. Bernardino Adao & Isabel Correia & Pedro Teles, 2003. "Gaps and Triangles," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 699-713, October.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  3. V. V. Chari & Patrick J. Kehoe, 1999. "Optimal Fiscal and Monetary Policy," NBER Working Papers 6891, National Bureau of Economic Research, Inc.
  4. Aubhik Khan & Robert King & Alexander L. Wolman, 2002. "Optimal monetary policy," Working Papers 02-19, Federal Reserve Bank of Philadelphia.
  5. 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.
  6. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc.
  7. Peter N. Ireland, 2001. "Money's Role in the Monetary Business Cycle," NBER Working Papers 8115, National Bureau of Economic Research, Inc.
  8. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
  9. Martin Uribe & Stephanie Schmitt-Grohe, 2001. "Optimal fiscal and monetary policy under sticky prices," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  10. Fabrice Collard & Harris Dellas, 2006. "Price Rigidity and the Selection of the Exchange Rate Regime," Open Economies Review, Springer, vol. 17(1), pages 5-26, January.
  11. Jinill Kim & Sunghyun Henry Kim, 1999. "Spurious Welfare Reversals in International Business Cycle Models," Virginia Economics Online Papers 319, University of Virginia, Department of Economics.
  12. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 704-23, August.
  13. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  14. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  15. Dale W. Henderson & Warwick J. McKibbin, 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," International Finance Discussion Papers 458, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Jordi Caballe & Jana Hromcova, 2001. "The Role of Central Bank Operating Procedures in an Economy with Productive Government Spending," UFAE and IAE Working Papers 504.01, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  2. Berger, Wolfram, 2008. "Monetary policy rules and the exchange rate," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 1064-1084, September.

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