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Real Effects of Price Stability with Endogenous Nominal Indexation


  • Césaire Meh
  • Vincenzo Quadrini
  • Yaz Terajima


We study a model with repeated moral hazard where financial contracts are not fully indexed to inflation because nominal prices are observed with delay as in Jovanovic & Ueda (1997). More constrained firms sign contracts that are less indexed to the nominal price and, as a result, their investment is more sensitive to nominal price shocks. We also find that the overall degree of nominal indexation increases with the uncertainty of the price level. An implication of this is that economies with higher price-level uncertainty are less vulnerable to a price shock of a given magnitude, that is, aggregate investment and output respond to a lesser degree.

Suggested Citation

  • Césaire Meh & Vincenzo Quadrini & Yaz Terajima, 2009. "Real Effects of Price Stability with Endogenous Nominal Indexation," Staff Working Papers 09-16, Bank of Canada.
  • Handle: RePEc:bca:bocawp:09-16

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    References listed on IDEAS

    1. Mark Gertler, 1992. "Financial Capacity and Output Fluctuations in an Economy with Multi-Period Financial Relationships," Review of Economic Studies, Oxford University Press, vol. 59(3), pages 455-472.
    2. Quadrini, Vincenzo, 2004. "Investment and liquidation in renegotiation-proof contracts with moral hazard," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 713-751, May.
    3. Fudenberg, Drew & Tirole, Jean, 1990. "Moral Hazard and Renegotiation in Agency Contracts," Econometrica, Econometric Society, vol. 58(6), pages 1279-1319, November.
    4. Gian Luca Clementi & Hugo A. Hopenhayn, 2006. "A Theory of Financing Constraints and Firm Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 121(1), pages 229-265.
    5. Jovanic, Boyan & Ueda, Masako, 1997. "Contracts and Money," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 700-708, August.
    6. Cheng Wang, 2000. "Renegotiation-Proof Dynamic Contracts with Private Information," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(3), pages 396-422, July.
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    Cited by:

    1. Iulian Vasile Popescu, 2012. "Price-Level Targeting – A Viable Alternative To Inflation Targeting?," CES Working Papers, Centre for European Studies, Alexandru Ioan Cuza University, vol. 4(4), pages 809-823, December.
    2. Meh, Césaire A. & Moran, Kevin, 2010. "The role of bank capital in the propagation of shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 555-576, March.
    3. repec:jes:wpaper:y:2012:v:4:p:809-823 is not listed on IDEAS
    4. Hatcher, Michael C., 2011. "Comparing inflation and price-level targeting: A comprehensive review of the literature," Cardiff Economics Working Papers E2011/22, Cardiff University, Cardiff Business School, Economics Section.

    More about this item


    Economic models; Monetary policy framework; Financial markets; Transmission of monetary policy;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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