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Inflation Inertia and Credible Disinflation - The Open Economy Case

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  • Guillermo Calvo
  • Oya Celasun
  • Michael Kumhof

Abstract

This paper develops a model of inflation inertia based on optimizing forward looking staggered price setting in a small open economy. Unlike in current models of sticky prices, transitions to a lower steady state inflation rate take time even if they are fully credible, and they are associated with significant output losses. There is a welfare trade-off between these output losses and the gains from smaller inflationary distortions. For reasonable parameter values inflation stabilization improves welfare. The optimal steady state is reached at the Friedman rule. Technical appendices are available at www.nber.org/data-appendix/w9557/ inert-techapp.pdf

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9557.

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Date of creation: Mar 2003
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Publication status: published as Calvo, Guillermo, O. Celasun and M. Kumhof. “Inflation Inertia and Credible Disinflation – The Open Economy Case." Journal of International Economics (2007).
Handle: RePEc:nbr:nberwo:9557

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  1. Laurence Ball, 1993. "What determines the sacrifice ratio?," Working Papers 93-21, Federal Reserve Bank of Philadelphia.
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Cited by:
  1. Le, Vo Phuong Mai & Minford, Patrick, 2007. "Optimising indexation arrangements under Calvo contracts and their implications for monetary policy," Cardiff Economics Working Papers E2007/7, Cardiff University, Cardiff Business School, Economics Section.
  2. Marco Vega & Diego Winkelried, 2004. "How Does Global Disinflation Drag Inflation in Small Open Economies?," Macroeconomics, EconWPA 0403008, EconWPA.
  3. Michael Kumhof & Douglas Laxton, 2005. "A Rational Expectations Model of Optimal Inflation Inertia," Computing in Economics and Finance 2005, Society for Computational Economics 429, Society for Computational Economics.
  4. Michel Juillard & Michael Kumhof & Ondra Kamenik, 2005. "Optimal price setting and inflation inertia in a rational expectations model," Proceedings, Board of Governors of the Federal Reserve System (U.S.), Board of Governors of the Federal Reserve System (U.S.).
  5. Agénor, Pierre-Richard & Bayraktar, Nihal, 2010. "Contracting models of the Phillips curve empirical estimates for middle-income countries," Journal of Macroeconomics, Elsevier, Elsevier, vol. 32(2), pages 555-570, June.
  6. Michael Kumhof, 2004. "Inflation Inertia- THe Role of Multiple, Interacting Pricing Rigidities," Working Papers, Hong Kong Institute for Monetary Research 182004, Hong Kong Institute for Monetary Research.
  7. Michel Juillard & Ondrej Kamenik & Michael Kumhof & Douglas Laxton, 2006. "Measures of Potential Output from an Estimated DSGE Model of the United States," Working Papers, Czech National Bank, Research Department 2006/11, Czech National Bank, Research Department.
  8. Luis F. Céspedes C. & Claudio Soto G., 2006. "Inflation Targeting And Monetary Policy Credibility In Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, Central Bank of Chile, vol. 9(3), pages 53-70, December.
  9. Buiter, Willem H, 2006. "How Robust is the New Conventional Wisdom? The Surprising Fragility of the Theoretical Foundations of Inflation Targeting and Central Bank Independence," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5772, C.E.P.R. Discussion Papers.

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