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Contracts, Credibility, and Disinflation

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  • Stanley Fischer
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    Abstract

    Estimates of the cost of disinflation made before the recent reduction in the inflation rate varied widely. Estimates were made in terms of the sacrifice ratio -- the percentage points of GNP at an annual rate lost per percentage point reduction in the inflation rate. At one extreme it was argued thata resolute and credible monetary policy could reduce inflation virtually costlessly. At the other extreme were estimates that the sacrifice ratio exceeded 10. Costless immediate disinflation is not possible in an economy with long-term labor contracts. This paper sets out a simple contracting model of wage and output determination and uses it to calculate sacrifice ratios for a disinflation program, under the assumption that announced policy changes are immediately believed. Under this assumption disinflation with a structure of labor contracts like those of the United States would be less costly than typically estimated.The model is then modified to allow for the slow adjustment of expectations of policy to actual policy; sacrifice ratios then approach the ranges typically estimated. The sacrifice ratio for the current disinflation is calculated in the last section: the current disinflation was somewhat more rapid and less costly than previous estimates suggested. The calculated sacrifice ratio is consistent with the predictions of the simple contracting model.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1339.

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    Date of creation: Apr 1986
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    Publication status: published as Fischer, Stanley. "Contracts, Credibility and Disinflation." Inflation and Unemployment: Theory, Experience and Policy Making, edited by Victor Argyand John Nevile, pp. 39-59. London: George Allen & Unwin, Ltd., 1985
    Handle: RePEc:nbr:nberwo:1339

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    1. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(1), pages 1-23, February.
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    Cited by:
    1. Bennett T. McCallum, 1984. "Credibility and monetary policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 105-135.
    2. Laurence Ball, 1992. "Disinflation With Imperfect Credibility," NBER Working Papers 3983, National Bureau of Economic Research, Inc.
    3. Chan G. Huh & Kevin J. Lansing, 1998. "Federal Reserve credibility and inflation scares," Economic Review, Federal Reserve Bank of San Francisco, pages 3-16.
    4. Peter N. Ireland, 1996. "Stopping inflations, big and small," Working Paper, Federal Reserve Bank of Richmond 96-01, Federal Reserve Bank of Richmond.
    5. Klas Fregert & Lars Jonung, 2007. "Policy rule evaluation by contract-makers: 100 years of wage contract length in Sweden," European Economy - Economic Papers, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission 270, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
    6. Fregert, Klas & Jonung, Lars, 2008. "Inflation Targeting Is a Success, So Far: 100 Years of Evidence from Swedish Wage Contracts," Economics Discussion Papers 2008-24, Kiel Institute for the World Economy.
    7. Ireland, Peter N., 1995. "Optimal disinflationary paths," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1429-1448, November.
    8. Harmanta, M. Barik Bathaluddin & Jati Waluyo, 2010. "Inflation Targeting under Imperfect Credibility Based on the Aggregate Rational Inflation-Targeting Model for Bank Indonesia (ARIMBI): Lessons from the Indonesian Experience," Occasional Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number occ50, June.
    9. Diana N. Weymark, 2001. "Inflation Targeting, Announcements, and Imperfect Credibility," Vanderbilt University Department of Economics Working Papers 0124, Vanderbilt University Department of Economics, revised Apr 2002.
    10. Döpke, Jörg, 2004. "Real-time data and business cycle analysis in Germany," Discussion Paper Series 1: Economic Studies 2004,11, Deutsche Bundesbank, Research Centre.
    11. Neven Valev, 2000. "Building Monetary Credibility in a Transforming Economy," International Center for Public Policy Working Paper Series, at AYSPS, GSU, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University paper0212, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    12. Fregert, Klas & Jonung, Lars, 1998. "Monetary Regimes And Endogenous Wage Contracts: Sweden 1908-1995," Working Papers 1998:3, Lund University, Department of Economics, revised 21 Apr 1999.
    13. Sebastian Edwards, 1996. "A Tale of Two Crises: Chile and Mexico," NBER Working Papers 5794, National Bureau of Economic Research, Inc.
    14. Sajid Anwar & S. Zahid Ali, 2007. "Exogenous Shocks and Exchange Rate Management in Developing Countries," Finance Working Papers 22245, East Asian Bureau of Economic Research.

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