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Monetary Policy with an Endogenous Capital Stock When Inflation Is Persistent

  • Mash, Richard

The paper presents a monetary policy model with an endogenous capital stock when a backward looking element in wage setting causes inflation persistence. We analyse how the endogeneity of the capital stock changes the macroeconomic dynamics with which policy interacts and its implications for optimal policy and time inconsistency. Capital stock endogeneity makes inflation more persistent in reduced form. This makes the optimal contemporaneous policy response to shocks more vigorous but the subsequent return to steady state more gradual. Observed output becomes more serially correlated. Capital endogeneity can also give rise to disinflation bias under discretion for some parameter values. Copyright 2002 by Blackwell Publishers Ltd and The Victoria University of Manchester

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Article provided by University of Manchester in its journal Manchester School.

Volume (Year): 70 (2002)
Issue (Month): 0 (Supplement)
Pages: 55-86

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Handle: RePEc:bla:manchs:v:70:y:2002:i:0:p:55-86
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