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Pricing Policies and Inflation Inertia

  • Luis Felipe Céspedes
  • Michael Kumhof
  • Eric Parrado

The paper proposes a monetary model with nominal rigidities that differs from the conventional New Keynesian model in that firms set pricing policies instead of price levels. In response to permanent or highly persistent monetary policy shocks this model generates the empirically observed slow (inertial) and prolonged (persistent) reaction of the inflation rate, and also the recession which typically accompanies moderate disinflations. The reason is that firms respond to such shocks mostly through achange in the long-run or inflation updating component of their pricing policies. With staggered pricing policies this takes time to be reflected in aggregate inflation.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 232.

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Date of creation: Oct 2003
Date of revision:
Handle: RePEc:chb:bcchwp:232
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