IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/6325.html
   My bibliography  Save this paper

Optimising Indexation Arrangements under Calvo Contracts and their Implications for Monetary Policy

Author

Listed:
  • Le, Vo Phuong Mai
  • Minford, Patrick

Abstract

This paper investigates optimal indexation in the New Keynesian model, when the indexation choice includes the possibility of partial indexation and of varying weights on rational and lagged indexation. It finds that the Calvo contract adjusted for rationally expected indexation under both inflation and price level targeting regimes delivers the highest expected welfare under both restricted and full current information. Rational indexation eliminates the effectiveness of monetary policy on welfare when there is only price-level targeting under the current micro information. If including both wage setting and full current information, monetary policy is effective; and a price-level targeting rule delivers the highest benefits because it minimises the size of shocks to prices and thus dispersion. However, even less than full rational indexation ensures that there is very little nominal rigidity in the adapted world of Calvo contracts.

Suggested Citation

  • Le, Vo Phuong Mai & Minford, Patrick, 2007. "Optimising Indexation Arrangements under Calvo Contracts and their Implications for Monetary Policy," CEPR Discussion Papers 6325, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6325
    as

    Download full text from publisher

    File URL: http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=6325
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Jeremy Rudd & Karl Whelan, 2006. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?," American Economic Review, American Economic Association, vol. 96(1), pages 303-320, March.
    2. Miguel Casares, 2004. "Price setting and the steady-state effects of inflation," Spanish Economic Review, Springer;Spanish Economic Association, vol. 6(4), pages 267-289, December.
    3. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2003. "Optimal Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 825-860.
    4. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    5. Jagjit S. Chadha & Charles Nolan, 2002. "Inflation and Price Level Targeting in a New Keynesian Model," Manchester School, University of Manchester, vol. 70(4), pages 570-595, June.
    6. Guido Ascari, 2004. "Staggered Prices and Trend Inflation: Some Nuisances," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 642-667, July.
    7. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    8. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92, National Bureau of Economic Research, Inc.
    9. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    10. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 2019. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Credit and Capital Markets, Credit and Capital Markets, vol. 52(4), pages 537-571.
    11. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    12. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    13. Lars E. O. Svensson, 2001. "Price Stability as a Target for Monetary Policy: Defining and Maintaining Price Stability," Palgrave Macmillan Books, in: Deutsche Bundesbank (ed.), The Monetary Transmission Process, chapter 2, pages 60-111, Palgrave Macmillan.
    14. Julio J. 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.
    15. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    16. Mr. Michael Kumhof & Mr. Eric Parrado & Mr. Luis Felipe Céspedes, 2003. "Pricing Policies and Inflation Inertia," IMF Working Papers 2003/087, International Monetary Fund.
    17. Minford, Patrick & Peel, David, 2002. "Exploitability as a Specification Test of the Phillips Curve," CEPR Discussion Papers 3612, C.E.P.R. Discussion Papers.
    18. Guillermo Calvo & Oya Celasun & Michael Kumhof, 2003. "Inflation Inertia and Credible Disinflation - The Open Economy Case," NBER Working Papers 9557, National Bureau of Economic Research, Inc.
    19. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
    20. Martin S. Eichenbaum & Jonas D. M. Fisher, 2003. "Testing the Calvo model of sticky prices," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 27(Q II), pages 40-53.
    21. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
    22. Bayoumi, Tamim & Laxton, Douglas & Pesenti, Paolo, 2004. "Benefits and spillovers of greater competition in Europe: a macroeconomic assessment," Working Paper Series 341, European Central Bank.
    23. Minford, Patrick & Peel, David, 2004. "Calvo Contracts: A Critique," CEPR Discussion Papers 4288, C.E.P.R. Discussion Papers.
    24. Fair, Ray C & Taylor, John B, 1990. "Full Information Estimation and Stochastic Simulation of Models with Rational Expectations," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 5(4), pages 381-392, Oct.-Dec..
    25. Patrick Minford & Eric Nowell & Bruce Webb, 2003. "Nominal Contracting and Monetary Targets -- Drifting into Indexation," Economic Journal, Royal Economic Society, vol. 113(484), pages 65-100, January.
    26. Le, Vo Phuong Mai & Minford, Patrick, 2006. "Calvo Contracts - Optimal Indexation in General Equilibrium," CEPR Discussion Papers 5616, C.E.P.R. Discussion Papers.
    27. Minford, Patrick & Nowell, Eric & Sofat, Prakriti & Srinivasan, Naveen, 2006. "UK Inflation Persistence: Policy or Nature?," CEPR Discussion Papers 5608, C.E.P.R. Discussion Papers.
    28. Patrick Minford, 2006. "What are the Right Models and Policies for a World of Low Inflation?," National Institute Economic Review, National Institute of Economic and Social Research, vol. 196(1), pages 92-106, April.
    29. Hasan Bakhshi & Pablo Burriel-Llombart, 2003. "Endogenous Price Stickiness, Trend Inflation, and the New Keynesian Phillips Curve," Computing in Economics and Finance 2003 12, Society for Computational Economics.
    30. Martin Neil Baily, 1974. "Wages and Employment under Uncertain Demand," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 37-50.
    31. McCallum, Bennett T & Nelson, Edward, 1999. "An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(3), pages 296-316, August.
    32. Ball, Laurence, 1994. "Credible Disinflation with Staggered Price-Setting," American Economic Review, American Economic Association, vol. 84(1), pages 282-289, March.
    33. Rudd, Jeremy & Whelan, Karl, 2003. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics," Research Technical Papers 5/RT/03, Central Bank of Ireland.
    34. McCallum, Bennett T., 1998. "Stickiness: A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 49(1), pages 357-363, December.
    35. Clark, Peter B. & Goodhart, Charles A. E. & Huang, Haizhou, 1999. "Optimal monetary policy rules in a rational expectations model of the Phillips curve," Journal of Monetary Economics, Elsevier, vol. 43(2), pages 497-520, April.
    36. Malcomson, James M., 1999. "Individual employment contracts," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 35, pages 2291-2372, Elsevier.
    37. Barro, Robert J., 1977. "Long-term contracting, sticky prices, and monetary policy," Journal of Monetary Economics, Elsevier, vol. 3(3), pages 305-316, July.
    38. Malcomson, James M., 1999. "Individual employment contracts," Handbook of Labor Economics,in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 35, pages 2291-2372 Elsevier.
    39. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
    40. Harris Dellas & Fabrice Collard, 2004. "Inflation targeting," Computing in Economics and Finance 2004 97, Society for Computational Economics.
    41. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2004. "The Cost of Nominal Inertia in NNS Models," NBER Working Papers 10889, National Bureau of Economic Research, Inc.
    42. William T. Gavin & Alan C. Stockman, 1988. "The case for zero inflation," Economic Commentary, Federal Reserve Bank of Cleveland, issue Sep.
    43. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-254, April.
    44. Chadha, Jagjit S & Nolan, Charles, 2002. "Inflation and Price Level Targeting in a New Keynesian Model," Manchester School, University of Manchester, vol. 70(4), pages 570-595, Special I.
    45. Charles T. Carlstrom & Timothy S. Fuerst, 2002. "Monetary policy rules and stability: inflation targeting versus price-level targeting," Economic Commentary, Federal Reserve Bank of Cleveland, issue Feb.
    46. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Minford, Patrick & Peel, David, 2004. "Calvo Contracts: A Critique," CEPR Discussion Papers 4288, C.E.P.R. Discussion Papers.
    2. Le, Vo Phuong Mai & Minford, Patrick, 2006. "Calvo Contracts - Optimal Indexation in General Equilibrium," CEPR Discussion Papers 5616, C.E.P.R. Discussion Papers.
    3. Thorvardur Tjörvi Ólafsson, 2006. "The New Keynesian Phillips Curve: In Search of Improvements and Adaptation to the Open Economy," Economics wp31_tjorvi, Department of Economics, Central bank of Iceland.
    4. Patrick Minford & David Peel, 2003. "Optimal monetary policy: is price‐level targeting the next step?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 650-667, November.
    5. Etro, Federico, 2017. "Research in economics and macroeconomics," Research in Economics, Elsevier, vol. 71(3), pages 373-383.
    6. Federico Di Pace & Matthias Hertweck, 2019. "Labor Market Frictions, Monetary Policy, and Durable Goods," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 32, pages 274-304, April.
    7. Juillard, Michael & Kamenik, Ondra & Kumhof, Michael & Laxton, Douglas, 2008. "Optimal price setting and inflation inertia in a rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2584-2621, August.
    8. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    9. Rudd, Jeremy & Whelan, Karl, 2005. "Modelling Inflation Dynamics: A Critical Review of Recent Research," Research Technical Papers 7/RT/05, Central Bank of Ireland.
    10. Mash, Richard, 2002. "New Keynesian Microfoundations Revisited: A Generalised Calvo-Taylor Model and the Desirability of Inflation vs. Price Level Targeting," Royal Economic Society Annual Conference 2002 138, Royal Economic Society.
    11. Hasan Bakhshi & Pablo Burriel-Llombart & Hashmat Khan & Barbara Rudolf, 2003. "Endogenous price stickiness, trend inflation, and the New Keynesian Phillips curve," Bank of England working papers 191, Bank of England.
    12. Jeremy Rudd & Karl Whelan, 2007. "Modeling Inflation Dynamics: A Critical Review of Recent Research," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 155-170, February.
    13. Richard Mash, 2003. "New Keynesian Microfoundations Revisited: A Calvo-Taylor-Rule-of-Thumb Model and Optimal Monetary Policy Delegation," Economics Series Working Papers 174, University of Oxford, Department of Economics.
    14. Dennis, Richard & Soderstrom, Ulf, 2006. "How Important Is Precommitment for Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 847-872, June.
    15. Gregory Erin Givens, 2006. "Revisiting the Delegation Problem in a Sticky Price and Wage Economy," Working Papers 200601, Middle Tennessee State University, Department of Economics and Finance.
    16. repec:spo:wpecon:info:hdl:2441/f4rshpf3v1umfa09lat09b1bg is not listed on IDEAS
    17. Guido Ascari, 2004. "Staggered Prices and Trend Inflation: Some Nuisances," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 642-667, July.
    18. Arslan, M. Murat, 2008. "Dynamics of sticky information and sticky price models in a New Keynesian DSGE framework," Economic Modelling, Elsevier, vol. 25(6), pages 1276-1294, November.
    19. Philip Arestis & Alexander Mihailov, 2011. "Classifying Monetary Economics: Fields And Methods From Past To Future," Journal of Economic Surveys, Wiley Blackwell, vol. 25(4), pages 769-800, September.
    20. Ronny Mazzocchi, 2013. "Scope and Flaws of the New Neoclassical Synthesis," DEM Discussion Papers 2013/13, Department of Economics and Management.
    21. Michel Juillard & Ondrej Kamenik & Michael Kumhof & Douglas Laxton, 2006. "Measures of Potential Output from an Estimated DSGE Model of the United States," Working Papers 2006/11, Czech National Bank.

    More about this item

    Keywords

    Calvo contracts; inflation target; New Keynesian model; optimal indexation; price-level target; rational expectation;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:6325. 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: . General contact details of provider: https://www.cepr.org .

    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 CitEc recognized a bibliographic reference but did not link an item in RePEc 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 RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (email available below). General contact details of provider: https://www.cepr.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.