IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this article or follow this journal

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/B6VBW-48NC15W-2/2/3cca53043753459caf74d84c8eb740f3
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. Thomas J. Sargent, 1981. "Stopping moderate inflations: the methods of Poincaré and Thatcher," Working Papers 1, Federal Reserve Bank of Minneapolis.
  2. Fuhrer, Jeffrey C. & Hooker, Mark A., 1993. "Learning about monetary regime shifts in an overlapping wage contract model," Journal of Economic Dynamics and Control, Elsevier, vol. 17(4), pages 531-553, July.
  3. John M. Roberts, 2001. "How well does the New Keynesian sticky-price model fit the data?," Finance and Economics Discussion Series 2001-13, Board of Governors of the Federal Reserve System (U.S.).
  4. Peter N. Ireland, 1999. "Expectations, Credibility, and Time-Consistent Monetary Policy," NBER Working Papers 7234, National Bureau of Economic Research, Inc.
  5. Jason G. Cummins & Kevin A. Hassett & Stephen D. Oliner, 1999. "Investment behavior, observable expectations, and internal funds," Finance and Economics Discussion Series 1999-27, Board of Governors of the Federal Reserve System (U.S.).
  6. Lawrence J. Christiano & Christopher J. Gust, 2000. "The Expectations Trap Hypothesis," NBER Working Papers 7809, National Bureau of Economic Research, Inc.
  7. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  8. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  9. Laurence Ball, 1993. "What determines the sacrifice ratio?," Working Papers 93-21, Federal Reserve Bank of Philadelphia.
  10. Marvin Goodfriend, 1993. "Interest rate policy and the inflation scare problem: 1979-1992," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-24.
  11. Marvin Goodfriend, 1997. "Monetary policy comes of age: a 20th century odyssey," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-22.
  12. Taylor, John B, 1983. "Union Wage Settlements during a Disinflation," American Economic Review, American Economic Association, vol. 73(5), pages 981-93, December.
  13. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  14. 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.
  15. Matthew D. Shapiro, 1984. "The Dynamic Demand for Capital and Labor," Cowles Foundation Discussion Papers 735, Cowles Foundation for Research in Economics, Yale University.
  16. Laurence M. Ball, 1990. "Time-Consistent Policy and Persistent Changes in Inflation," NBER Working Papers 3529, National Bureau of Economic Research, Inc.
  17. 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.).
  18. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series WP-01-08, Federal Reserve Bank of Chicago.
  19. Antulio Bomfim & Robert 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.).
  20. 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.
  21. 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.
  22. Goodfriend, Marvin, 1991. "Interest rates and the conduct of monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 34(1), pages 7-30, January.
  23. 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.).
  24. 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.
  25. Ireland, Peter N., 1995. "Optimal disinflationary paths," Journal of Economic Dynamics and Control, Elsevier, vol. 19(8), pages 1429-1448, November.
  26. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Sticky price models of the business cycle: can the contract multiplier solve the persistence problem?," Staff Report 217, Federal Reserve Bank of Minneapolis.
  27. Rochelle M. Edge, 2000. "The equivalence of wage and price staggering in monetary business cycle models," International Finance Discussion Papers 672, Board of Governors of the Federal Reserve System (U.S.).
  28. Laurence Ball, 1990. "Credible Disinflation with Staggered Price Setting," NBER Working Papers 3555, National Bureau of Economic Research, Inc.
  29. 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.
  30. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  31. Athanasios Orphanides amd John Williams, 2001. "Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2001 254, Society for Computational Economics.
  32. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc.
  33. Laurence Ball, 2000. "Near-rationality and inflation in two monetary regimes," Proceedings, Federal Reserve Bank of San Francisco.
  34. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  35. Aksoy, Yunus & Orphanides, Athanasios & Small, David & Wieland, Volker & Wilcox, David, 2003. "A Quantitative Exploration of the Opportunistic Approach to Disinflation," CEPR Discussion Papers 4073, C.E.P.R. Discussion Papers.
  36. 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.
  37. Peter N. Ireland, 1996. "Stopping inflations, big and small," Working Paper 96-01, Federal Reserve Bank of Richmond.
  38. 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.
  39. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
  40. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
  41. Athanasios Orphanides, 2000. "Activist stabilization policy and inflation: the Taylor rule in the 1970s," Finance and Economics Discussion Series 2000-13, Board of Governors of the Federal Reserve System (U.S.).
  42. 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.
  43. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  44. Rochelle M. Edge, 2001. "Online Appendix to "The Equivalence of Wage and Price Staggering in Monetary Business Cycle Models"," Technical Appendices edge01, Review of Economic Dynamics.
  45. Eberly, Janice C., 1997. "International evidence on investment and fundamentals," European Economic Review, Elsevier, vol. 41(6), pages 1055-1078, June.
  46. 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.
  47. 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.
  48. Martin Evans & Paul Wachtel, 1993. "Inflation regimes and the sources of inflation uncertainty," Proceedings, Federal Reserve Bank of Cleveland, pages 475-520.
  49. 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.).
  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. 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.
  52. Taylor, John B, 1982. "Establishing Credibility: A Rational Expectations Viewpoint," American Economic Review, American Economic Association, vol. 72(2), pages 81-85, May.
  53. Jeffrey Sachs, 1985. "The Dollar and the Policy Mix: 1985," NBER Working Papers 1636, National Bureau of Economic Research, Inc.
  54. Evans, Martin & Wachtel, Paul, 1993. "Inflation Regimes and the," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(3), pages 475-511, August.
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.