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Learning About Inflation Measures for Interest Rate Rules

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  • Luis-Felipe Zanna
  • Marco Airaudo
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    Abstract

    Empirical evidence suggests that goods are highly heterogeneous with respect to the degree of price rigidity. We develop a DSGE model featuring heterogeneous nominal rigidities across two sectors to study the equilibrium determinacy and stability under adaptive learning for interest rate rules that respond to inflation measures differing in their degree of price stickiness. We find that rules responding to headline inflation measures that assign a positive weight to the inflation of the sector with low price stickiness are more prone to generate macroeconomic instability than rules that respond exclusively to the inflation of the sector with high price stickiness. By this we mean that they are more prone to induce non-learnable fundamental-driven equilibria, learnable self-fulfilling expectations equilibria, and equilibria where fluctuations are unbounded. We discuss how our results depend on the elasticity of substitution across goods, the degree of heterogeneity in price rigidity, as well as on the timing of the rule.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 10/296.

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    Length: 45
    Date of creation: 01 Dec 2010
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    Handle: RePEc:imf:imfwpa:10/296

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    Related research

    Keywords: Economic models; Inflation rates; Price stabilization; Stabilization measures; inflation; monetary policy; price inflation; monetary economics; rational expectations; measure of inflation; relative price; central bank; real interest rate; monetary policy rules; optimal monetary policy; nominal interest rate; inflationary pressures; money balances; price stability; monetary fund; nominal interest rates; inflation deviation; real money; inflationary shock; relative prices; macroeconomic stability; transmission of monetary policy; monetary models; monetary shocks; new money; macroeconomic analysis; aggregate demands;

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