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Disinflation Dynamics in an Open Economy General Equilibrium Model

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  • Özge Senay

Abstract

This paper studies money based and exchange rate based disinflation in an open economy model with explicit microfoundations. For benchmark parameter values, it is found that a money slowdown leads to a recession in the short run whereas exchange rate based disinflation leads to very rapid adjustment with minimal real effects. This corresponds to the results of directly postulated models. Overshooting of the exchange rate in response to a money slowdown, however, only occurs when there is pricing-to-market behavior. It is found that by varying certain key parameter values such as the intertemporal rate of discount and the degree of price inertia, exchange rate based stabilization can produce substantial real effects. This contrasts with the results of directly postulated models and is related to issues highlighted by the introduction of microfoundations.

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Paper provided by Department of Economics, University of York in its series Discussion Papers with number 98/15.

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Handle: RePEc:yor:yorken:98/15

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Keywords: disinflation; staggered prices; persistence; dynamic general equilibrium; pricing-to-market;

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  1. Betts, Caroline & Devereux, Michael B., 1996. "The exchange rate in a model of pricing-to-market," European Economic Review, Elsevier, vol. 40(3-5), pages 1007-1021, April.
  2. Sutherland, Alan, 1996. " Financial Market Integration and Macroeconomic Volatility," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(4), pages 521-39, December.
  3. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, Elsevier, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier.
  4. John B. Taylor, 1982. "Union Wage Settlements During a Disinflation," NBER Working Papers 0985, National Bureau of Economic Research, Inc.
  5. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
  6. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: A Quantitative Investigation," Cahiers de recherche, Centre interuniversitaire de recherche en économie quantitative, CIREQ 9614, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  7. Willem H. Buiter & Marcus Miller, 1991. "Real Exchange Rate Overshooting and the Output Cost of Bringing Down Inflation," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 239-277 National Bureau of Economic Research, Inc.
  8. Guido Ascari & Neil Rankin, 1997. "Staggered Wages and Disinflation Dynamics: What can More Microfoundations Tell Us," Discussion Papers 97-16, University of Copenhagen. Department of Economics.
  9. 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.
  10. Laurence Ball, 1992. "Disinflation With Imperfect Credibility," NBER Working Papers 3983, National Bureau of Economic Research, Inc.
  11. Willem H. Buiter & Marcus H. Miller, 1983. "Costs and Benefits of an Anti-Inflationary Policy: Questions and Issues," NBER Working Papers 1252, National Bureau of Economic Research, Inc.
  12. Hairault, J.O. & Portier, F., 1992. "Money New-Keynesian Macroeconomics and the Business Cycles," Papiers d'Economie Mathématique et Applications, Université Panthéon-Sorbonne (Paris 1) 92.32, Université Panthéon-Sorbonne (Paris 1).
  13. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-13, May.
  14. Laurence Ball, 1990. "Credible Disinflation with Staggered Price Setting," NBER Working Papers 3555, National Bureau of Economic Research, Inc.
  15. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  16. Blanchard, Olivier Jean & Summers, Lawrence H, 1988. "Beyond the Natural Rate Hypothesis," American Economic Review, American Economic Association, vol. 78(2), pages 182-87, May.
  17. Senay, Ozge, 1998. "The Effects of Goods and Financial Market Integration on Macroeconomic Volatility," The Manchester School of Economic & Social Studies, University of Manchester, University of Manchester, vol. 66(0), pages 39-61, Supplemen.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  19. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 85(1), pages 191-205, February.
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