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Discretionary Monetary Policy and Inflation Persistence

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Abstract

Rational expectations models of staggered price/wage contracts have failed to replicate the observed persistence in inflation and unemployment during disinflation periods. The current literature on this persistency puzzle has focused on augmenting the nominal contract model with imperfect credibility and learning. In this paper, I re-examine the persistency puzzle by focusing on the discretionary nature of monetary policy. I show that when the central bank is allowed to re-optimize a quadratic loss function each period, imperfect credibility and learning, even in the absence of staggered contracts, can generate a significant amount of inflation persistence and employment losses during a disinflationary period.

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Bibliographic Info

Paper provided by Hunter College Department of Economics in its series Economics Working Paper Archive at Hunter College with number 424.

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Date of creation: 2005
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Handle: RePEc:htr:hcecon:424

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Keywords: Monetary policy; Disinflation; Credibility; Inflation persistence;

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References

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  1. David Andolfatto & Paul Gomme, 2001. "Monetary policy regimes and beliefs," Working Paper 9905, Federal Reserve Bank of Cleveland.
  2. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  3. Taylor, John B, 1983. "Union Wage Settlements during a Disinflation," American Economic Review, American Economic Association, vol. 73(5), pages 981-93, December.
  4. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Finance and Economics Discussion Series 93-17, Board of Governors of the Federal Reserve System (U.S.).
  5. Ball, Laurence, 1994. "Credible Disinflation with Staggered Price-Setting," American Economic Review, American Economic Association, vol. 84(1), pages 282-89, March.
  6. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters, in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
  7. Laurence Ball, 1992. "Disinflation With Imperfect Credibility," NBER Working Papers 3983, National Bureau of Economic Research, Inc.
  8. John B. Taylor, 1998. "Staggered Price and Wage Setting in Macroeconomics," NBER Working Papers 6754, National Bureau of Economic Research, Inc.
  9. Chan G. Huh & Kevin J. Lansing, 1997. "Expectations, credibility, and disinflation in a small macroeconomic model," Working Paper 9713, Federal Reserve Bank of Cleveland.
  10. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  11. Ireland, Peter N., 1999. "Does the time-consistency problem explain the behavior of inflation in the United States?," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 279-291, October.
  12. Christopher J. Erceg & Andrew T. Levin, 2001. "Imperfect credibility and inflation persistence," Finance and Economics Discussion Series 2001-45, Board of Governors of the Federal Reserve System (U.S.).
  13. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  14. Ireland, Peter N., 1995. "Optimal disinflationary paths," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1429-1448, November.
  15. Edmund Phelps, 1978. "Disinflation without recession: Adaptive guideposts and monetary policy," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 114(4), pages 783-809, December.
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Cited by:
  1. Carvalho, Carlos Viana de & Bonomo, Marco Antônio Cesar, 2005. "Imperfectly Credible Disinflation under Endogenous Time-Dependent Pricing," Economics Working Papers (Ensaios Economicos da EPGE) 600, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  2. Marco Bonomo & Carlos Viana de Carvalho, 2005. "Endogenous Time-Dependent Rules and the Costs of Disinflation with Imperfect Credibility," Macroeconomics 0509004, EconWPA.
  3. Muhammad, Omer & de Haan, Jakob & Scholtens, Bert, 2014. "An Empirical Analysis of Excess Interbank Liquidity: A Case Study of Pakistan," MPRA Paper 56143, University Library of Munich, Germany.
  4. Dai, Meixing & Sidiropoulos, Moïse & Spyromitros, Eleftherios, 2008. "Monetary policy transparency and inflation persistence in a small open economy," MPRA Paper 13829, University Library of Munich, Germany, revised Mar 2009.
  5. Karanassou, Marika & Snower, Dennis J., 2007. "Inflation Persistence and the Phillips Curve Revisited," IZA Discussion Papers 2600, Institute for the Study of Labor (IZA).
  6. Naveen Srinivasan & Pankaj Kumar, 2012. "Inflation Persistence: Does Credibility of the Monetary Regime Matter?," Economics Bulletin, AccessEcon, vol. 32(4), pages 2944-2954.
  7. Agnieszka Leszczynska & Katarzyna Hertel, 2013. "Inflation persistence – a disaggregated approach," EcoMod2013 5692, EcoMod.

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