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Trend Inflation, Wage and Price Rigidities, and Welfare

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  • Robert Amano
  • Kevin Moran
  • Stephen Murchison
  • Andrew Rennison

Abstract

This paper studies the steady-state costs of inflation in a general-equilibrium model with real per capita output growth and staggered nominal price and wage contracts. Our analysis shows that trend inflation has important effects on the economy when combined with nominal contracts and real output growth. Steady-state output and welfare losses are quantitatively important even for low values of trend inflation. Further, we show that nominal wage contracting is quantitatively more important than nominal price contracting in generating these losses. This important result does not arise from price dispersion per se but from an effect of nominal output growth on the optimal markup of monopolistically competitive labour suppliers. We also demonstrate that accounting for productivity growth is important for calculating the welfare costs of inflation. Indeed, the presence of two percent productivity growth increases the welfare costs of inflation in our benchmark specification by a factor of four relative to the no-growth case.

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Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 0720.

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Date of creation: 2007
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Handle: RePEc:lvl:lacicr:0720

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Keywords: Inflation; costs and benefits; wage and price rigidities;

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References

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  1. John B. Taylor, 1998. "Staggered Price and Wage Setting in Macroeconomics," NBER Working Papers 6754, National Bureau of Economic Research, Inc.
  2. Graham, Liam & Snower, Dennis J., 2004. "The real effects of money growth in dynamic general equilibrium," Working Paper Series 0412, European Central Bank.
  3. Susanto Basu, 1995. "Procyclical Productivity: Increasing Returns or Cyclical Utilization?," NBER Working Papers 5336, National Bureau of Economic Research, Inc.
  4. Robert G. King & Alexander L. Wolman, 1996. "Inflation Targeting in a St. Louis Model of the 21st Century," NBER Working Papers 5507, National Bureau of Economic Research, Inc.
  5. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  6. Alexander L. Wolman, 2009. "The optimal rate of inflation with trending relative prices," Working Paper 09-02, Federal Reserve Bank of Richmond.
  7. Ascari, Guido, 2003. "Staggered prices and trend inflation: some nuisances," Research Discussion Papers 27/2003, Bank of Finland.
  8. K. Huang & Z. Liu, . "Staggered price-setting, staggered wage-setting, and business cycle persistence," Working Papers 2000-28, Utah State University, Department of Economics.
  9. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2002. "Optimal Monetary Policy," NBER Working Papers 9402, National Bureau of Economic Research, Inc.
  10. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  11. Basu, Susanto & Fernald, John G, 1997. "Returns to Scale in U.S. Production: Estimates and Implications," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 249-83, April.
  12. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  13. Alexander L. Wolman, 2001. "A primer on optimal monetary policy with staggered price-setting," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 27-52.
  14. Ascari, Guido, 1998. "Superneutrality Of Money In Staggered Wage-Setting Models," Macroeconomic Dynamics, Cambridge University Press, vol. 2(03), pages 383-400, September.
  15. Andreas Hornstein & Alexander L. Wolman, 2005. "Trend inflation, firm-specific capital, and sticky prices," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 57-83.
  16. repec:cup:macdyn:v:2:y:1998:i:3:p:383-400 is not listed on IDEAS
  17. 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.
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Cited by:
  1. Amano, Robert & Moran, Kevin & Murchison, Stephen & Rennison, Andrew, 2009. "Trend inflation, wage and price rigidities, and productivity growth," Journal of Monetary Economics, Elsevier, vol. 56(3), pages 353-364, April.
  2. Hakan, Yilmazkuday, 2009. "Is there a Role for International Trade Costs in Explaining the Central Bank Behavior?," MPRA Paper 15951, University Library of Munich, Germany.

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