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Disinflation effects in a medium-scale New Keynesian model: money supply rule versus interest rate rule

  • Guido Ascari

    ()

    (University of Pavia)

  • Tiziano Ropele

    ()

    (Bank of Italy)

Empirical studies show that successful disinflations entail a period of output contraction. Using a medium-scale New Keynesian model, we compare the effects of disinflations of different speed and timing, implemented through either a money supply or an interest rate rule. In terms of transitional output loss, cold-turkey disinflations under an interest rate rule are less costly than those under a money supply rule and are accomplished more rapidly. Furthermore, gradual or anticipated disinflations deliver lower sacrifice ratios. From a welfare perspective, despite the transitional economic contraction, disinflations are overall welfare-improving. Interestingly, the overall welfare gain is not affected by how the disinflation is actually implemented: what really matters is the achievement of a permanently lower inflation rate.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 867.

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Date of creation: Apr 2012
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Handle: RePEc:bdi:wptemi:td_867_12
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