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Endogenous Indexing and Monetary Policy Models

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  • Mash, Richard

Abstract

Models in which firms use a rule of thumb or partial indexing in price setting are prominent in the recent monetary policy literature. The extent to which these firms adjust their prices to lagged inflation has been taken as fixed. We consider the implications of firms choosing the optimal degree of indexation so these simple pricing rules deliver prices as close as possible to those which would be chosen optimally. We find that the degree of indexation depends on the extent of persistence in the economy such that models with constant indexation are vulnerable to the Lucas critique. We also study the interactions between firms? price setting and the macroeconomic environment finding that, for the models which appear most plausible on microeconomic grounds, the Nash equilibrium between firms and the policy maker is characterised by zero indexation and zero macroeconomic persistence. --

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2007-36.

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Date of creation: 2007
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Handle: RePEc:zbw:ifwedp:6163

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Keywords: Indexing; Monetary Policy; Phillips Curve; Inflation Persistence; Microfoundations;

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  1. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
  2. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  3. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  4. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
  5. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  6. Martin Eichenbaum & Jonas D.M. Fisher, 2004. "Evaluating the Calvo Model of Sticky Prices," NBER Working Papers 10617, National Bureau of Economic Research, Inc.
  7. Bennett McCallum, 1999. "Role of the Minimal State Variable Criterion in Rational Expectations Models," International Tax and Public Finance, Springer, vol. 6(4), pages 621-639, November.
  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  9. Smets, Frank & Wouters, Raf, 2002. "An estimated stochastic dynamic general equilibrium model of the euro area," Working Paper Series 0171, European Central Bank.
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Cited by:
  1. Yao, Fang, 2009. "Time-dependent pricing and New Keynesian Phillips curve," Discussion Paper Series 1: Economic Studies 2009,08, Deutsche Bundesbank, Research Centre.

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