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Calvo pricing and imperfect common knowledge: a forward looking model of rational inflation inertia

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  • Nimark, Kristoffer P.

Abstract

In this paper we derive a Phillips curve with a role for higher order expectations of marginal cost and future inflation. We introduce a small idiosyncratic component in firms’ marginal costs and let the economywide average marginal cost be unobservable to the individual firm. The model can then replicate the backward looking component found in estimates of the ’Hybrid’ New Keynesian Phillips Curve, even though the pricing decision of the firm is entirely forward looking. The Phillips curve derived here nests the standard New Keynesian Phillips Curve as a special case. We take a structural approach to imperfect common knowledge that allow us to infer whether the assumed information imperfections necessary to replicate the data are quantitatively realistic or not. We also provide an algorithm for solving a class of models involving dynamic higher order expectations of endogenous variables. JEL Classification: E00, E31, E32

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0474.

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Date of creation: Apr 2005
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Handle: RePEc:ecb:ecbwps:20050474

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Related research

Keywords: Calvo pricing; Higher order expectations; Imperfect Common Knowledge; New-Keynesian Phillips Curve;

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References

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  1. Adam, Klaus, 2007. "Optimal monetary policy with imperfect common knowledge," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 267-301, March.
  2. 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.
  3. Hyun Song Shin & Jeffery D. Amato, 2003. "Public and private information in monetary policy models," BIS Working Papers 138, Bank for International Settlements.
  4. Carlton, Dennis W, 1986. "The Rigidity of Prices," American Economic Review, American Economic Association, vol. 76(4), pages 637-58, September.
  5. Jeffery Amato & Hyun Song Shin, 2003. "Public and Private Information in Monetary Policy Models," Levine's Bibliography 666156000000000092, UCLA Department of Economics.
  6. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  7. Hyun Song Shin & Jeffery D. Amato, 2003. "Public and Private Information in Monetary Policy Models," Computing in Economics and Finance 2003 38, Society for Computational Economics.
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Cited by:
  1. Adam, Klaus, 2003. "Optimal Monetary Policy with Imperfect Common Knowledge," CFS Working Paper Series 2003/12, Center for Financial Studies (CFS).
  2. Guido Lorenzoni, 2006. "A Theory of Demand Shocks," NBER Working Papers 12477, National Bureau of Economic Research, Inc.
  3. Ian Babetskii & Fabrizio Coricelli & Roman Horvath, 2007. "Measuring and Explaining Inflation Persistence: Disaggregate Evidence on the Czech Republic," Working Papers 2007/1, Czech National Bank, Research Department.
  4. Stephen Morris & Hyun Song Shin, 2006. "Inertia of Forward-Looking Expectations," American Economic Review, American Economic Association, vol. 96(2), pages 152-157, May.
  5. Jan Babecky & Fabrizio Coricelli & Roman Horvath, 2008. "Assessing Inflation Persistence: Micro Evidence on an Inflation Targeting Economy," CERGE-EI Working Papers wp353, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  6. Guido Lorenzoni, 2007. "News Shocks and Optimal Monetary Policy," NBER Working Papers 12898, National Bureau of Economic Research, Inc.

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