IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

Imperfect credibility and inflation persistence

  • Erceg, Christopher J.
  • Levin, Andrew T.

Contract structures typically embedded in a recent generation of models with nominal inertia have been criticized for a failure to generate persistent responses of output and inflation to nominal shocks. In this paper, we argue that this failure does not reflect an inherent limitation of the contract structure, but rather, very strong assumptions about central bank credibility. We show that an optimization-based DGE model with four-quarter price and wage contracts can generate highly persistent inflation and output responses when the private sector must use signal extraction to make inferences about the central bank's inflation target based on only observing the policy instrument. In particular, we consider the disinflation experiences of the United States and several other industrial countries in the early 1980s, and we demonstrate that the model matches the dynamics of both expected and actual inflation and generates sacrifice ratios which are roughly in line with empirical estimates.

(This abstract was borrowed from another version of this item.)

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.sciencedirect.com/science/article/pii/S0304-3932(03)00036-9
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 50 (2003)
Issue (Month): 4 (May)
Pages: 915-944

as
in new window

Handle: RePEc:eee:moneco:v:50:y:2003:i:4:p:915-944
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Athanasios Orphanides & David H. Small & Volker W. Wieland & David W. Wilcox, 1997. "A quantitative exploration of the opportunistic approach to disinflation," Finance and Economics Discussion Series 1997-36, Board of Governors of the Federal Reserve System (U.S.).
  2. Lawrence J. Christiano & Christopher J. Gust, 2000. "The Expectations Trap Hypothesis," NBER Working Papers 7809, National Bureau of Economic Research, Inc.
  3. Ireland, Peter N., 1995. "Optimal disinflationary paths," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1429-1448, November.
  4. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  5. Coenen Günter & Orphanides Athanasios & Wieland Volker, 2004. "Price Stability and Monetary Policy Effectiveness when Nominal Interest Rates are Bounded at Zero," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-25, February.
  6. Rochelle M. Edge, 2002. "The Equivalence of Wage and Price Staggering in Monetary Business Cycle Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(3), pages 559-585, July.
  7. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  8. Laurence Ball, 2000. "Near-Rationality and Inflation in Two Monetary Regimes," NBER Working Papers 7988, National Bureau of Economic Research, Inc.
  9. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 45(2), pages 329-359, April.
  10. Ball, Laurence, 1995. "Time-consistent policy and persistent changes in inflation," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 329-350, November.
  11. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
  12. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  13. Peter N. Ireland, 1996. "Stopping inflations, big and small," Working Paper 96-01, Federal Reserve Bank of Richmond.
  14. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  15. Marvin Goodfriend, 1990. "Interest rates and the conduct of monetary policy," Working Paper 90-06, Federal Reserve Bank of Richmond.
  16. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
  17. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  18. Huh, Chan G. & Lansing, Kevin J., 2000. "Expectations, credibility, and disinflation in a small macroeconomic model," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 51-86.
  19. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters, in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
  20. Christopher J. Erceg, 1997. "Nominal wage rigidities and the propagation of monetary disturbances," International Finance Discussion Papers 590, Board of Governors of the Federal Reserve System (U.S.).
  21. Jeffrey Sachs, 1985. "The Dollar and the Policy Mix: 1985," NBER Working Papers 1636, National Bureau of Economic Research, Inc.
  22. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  23. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  24. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters, in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
  25. Martin Evans & Paul Wachtel, 1993. "Inflation regimes and the sources of inflation uncertainty," Proceedings, Federal Reserve Bank of Cleveland, pages 475-520.
  26. Sharon Kozicki & Peter A. Tinsley, 1997. "Shifting endpoints in the term structure of interest rates," Research Working Paper 97-08, Federal Reserve Bank of Kansas City.
  27. Athanasios Orphanides & David W. Wilcox, 1996. "The opportunistic approach to disinflation," Finance and Economics Discussion Series 96-24, Board of Governors of the Federal Reserve System (U.S.).
  28. Jeffrey C. Fuhrer & Mark A. Hooker, 1988. "Learning about monetary regime shifts in an overlapping wage contract model," Finance and Economics Discussion Series 25, Board of Governors of the Federal Reserve System (U.S.).
  29. Taylor, John B, 1983. "Union Wage Settlements during a Disinflation," American Economic Review, American Economic Association, vol. 73(5), pages 981-93, December.
  30. Eberly, Janice C., 1997. "International evidence on investment and fundamentals," European Economic Review, Elsevier, vol. 41(6), pages 1055-1078, June.
  31. Marvin Goodfriend, 1993. "Interest rate policy and the inflation scare problem: 1979-1992," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  32. Ireland, Peter N., 2000. "Expectations, Credibility, And Time-Consistent Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 4(04), pages 448-466, December.
  33. Ball, Laurence, 1994. "Credible Disinflation with Staggered Price-Setting," American Economic Review, American Economic Association, vol. 84(1), pages 282-89, March.
  34. Athanasios Orphanides & John C. Williams, 2006. "Monetary Policy with Imperfect Knowledge," Journal of the European Economic Association, MIT Press, vol. 4(2-3), pages 366-375, 04-05.
  35. Gertler, Mark, 1982. "Imperfect Information and Wage Inertia in the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 90(5), pages 967-87, October.
  36. Jason G. Cummins & Kevin A. Hassett & Stephen D. Oliner, 2006. "Investment Behavior, Observable Expectations, and Internal Funds," American Economic Review, American Economic Association, vol. 96(3), pages 796-810, June.
  37. Marvin Goodfriend, 1997. "Monetary policy comes of age: a 20th century odyssey," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-22.
  38. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc.
  39. Thomas J. Sargent, 1981. "Stopping moderate inflations: the methods of Poincaré and Thatcher," Working Papers 1, Federal Reserve Bank of Minneapolis.
  40. Orphanides, Athanasios, 2002. "Activist stabilization policy and inflation: The Taylor rule in the 1970s," CFS Working Paper Series 2002/15, Center for Financial Studies (CFS).
  41. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
  42. Roberts John M., 2005. "How Well Does the New Keynesian Sticky-Price Model Fit the Data?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-39, September.
  43. Antulio N. Bomfim & Robert J. Tetlow & Peter von zur Muehlen & John Williams, 1997. "Expectations, learning and the costs of disinflation: experiments using the FRB/US model," Finance and Economics Discussion Series 1997-42, Board of Governors of the Federal Reserve System (U.S.).
  44. Evans, Martin & Wachtel, Paul, 1993. "Inflation Regimes and the," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(3), pages 475-511, August.
  45. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  46. Taylor, John B, 1982. "Establishing Credibility: A Rational Expectations Viewpoint," American Economic Review, American Economic Association, vol. 72(2), pages 81-85, May.
  47. Brunner, Karl & Cukierman, Alex & Meltzer, Allan H., 1980. "Stagflation, persistent unemployment and the permanence of economic shocks," Journal of Monetary Economics, Elsevier, vol. 6(4), pages 467-492, October.
  48. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  49. Matthew D. Shapiro, 1986. "The Dynamic Demand for Capital and Labor," The Quarterly Journal of Economics, Oxford University Press, vol. 101(3), pages 513-542.
  50. John M. Roberts, 1998. "Inflation expectations and the transmission of monetary policy," Finance and Economics Discussion Series 1998-43, Board of Governors of the Federal Reserve System (U.S.).
  51. Rochelle M. Edge, 2000. "Time-to-build, time-to-plan, habit-persistence, and the liquidity effect," International Finance Discussion Papers 673, Board of Governors of the Federal Reserve System (U.S.).
  52. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  53. Jeffrey D. Sachs, 1985. "The Dollar and the Policy Mix: 1985," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 16(1), pages 117-197.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:moneco:v:50:y:2003:i:4:p:915-944. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.