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Inflation, Wages and the Role of Money Under Discretion and Rules: A New Interpretation

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  • Yashiv, Eran

Abstract

This paper models a game-theoretic interaction between the monetary authority and a strategically active private sector. It aims to explore the real effects of monetary policy, wage setting behaviour and the consequences of stabilization and indexation policy. We find that when the private sector has an active role, "rules" and "discretion" are not as far apart as implied by the standard model prevalent in the literature. Both regimes are not Pareto-optimal equilibria and inflation may be positive even under "rules." We show that monetary policy may have real effects on output in the short-run due to strategic considerations by rational, petfectly informed wage-setters. The latter may act "tough" or "soft" depending upon the preferences of the policymaker facing them. We investigate the consequences of inflation stabilization policy and the means open to the government to mitigate its output costs. We also find that the prevalent intuition whereby more indexation should lead to more inflation is not always correct.

Suggested Citation

  • Yashiv, Eran, 1994. "Inflation, Wages and the Role of Money Under Discretion and Rules: A New Interpretation," Foerder Institute for Economic Research Working Papers 275585, Tel-Aviv University > Foerder Institute for Economic Research.
    • Handle: RePEc:ags:isfiwp:275585
    DOI: 10.22004/ag.econ.275585
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    References listed on IDEAS

    as
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    3. Yashiv, Eran, 1989. "Optimal inflation and the government revenue mix," Economics Letters, Elsevier, vol. 31(2), pages 151-154, December.
    4. repec:bla:scandj:v:87:y:1985:i:2:p:160-93 is not listed on IDEAS
    5. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
    6. Rogoff, Kenneth, 1987. "Reputational constraints on monetary policy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 26(1), pages 141-181, January.
    7. Lindbeck, Assar & Snower, Dennis J, 1988. "Long-term Unemployment and Macroeconomic Policy," American Economic Review, American Economic Association, vol. 78(2), pages 38-43, May.
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