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New Keynesian Microfundations Revisited: A Generalised Calvo-Taylor Model and the Desirability of Inflation vs. Price Level Targeting

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Richard Mash

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Abstract

Optimal monetary policy is sensitive to the Phillips curve specification used to represent the dynamics of inflation and output. Most recent literature has used a new Keynesian Phillips Curve based on Calvo pricing. This paper shows that this workhorse model is not robust to relatively minor changes in its microfoundations, in particular allowing for time varying probabilities of a firm being able to reset its price. We derive a general model that nests Calvo and the Taylor staggering model as special cases and analyse its implications for optimal policy, including the relative desirability of inflation and price level targeting.

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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 109.

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Date of creation: 2002
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Handle: RePEc:oxf:wpaper:109

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Keywords: New Keynesian Phillips Curve Stabilisation Bias Forwarding Looking Expectations Inflation Targeting Price Level Targeting

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis

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Cited by:
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  1. Bakhshi, Hasan & Khan, Hashmat & Rudolf, Barbara, 2006. "The Phillips Curve Under State-Dependent Pricing," CEPR Discussion Papers 5945, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Rudolf, B. & Bakhshi, H., 2005. "The Phillips Curve Under State-Dependent Pricing," Computing in Economics and Finance 2005 68, Society for Computational Economics. [Downloadable!]
  3. Richard Mash, 2004. "Optimising microfoundations for observed inflation persistence," Money Macro and Finance (MMF) Research Group Conference 2003 60, Money Macro and Finance Research Group. [Downloadable!]
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