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Inflation persistence and optimal monetary policy in the euro area

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  • Benigno, Pierpaolo
  • López-Salido, David

Abstract

In this paper we present supporting evidence of the existence of heterogeneity in inflation dynamics across euro area countries. Based on the estimation of New Phillips Curves for five major countries of the euro area, we find that there is significant inertial (backward looking) behavior in inflation in four of them, while inflation in Germany has a dominat forward looking component. We then present an optimizing agent model for the area emphasizing the hetergeneity in inflation persistence across regions. Allowing for such a backward looking component will affect the evaluation of the degree of nominal rigidities relevant for the monetary policy design. We explore the welfare implications of this circumstance by comparing the adjustment of the economies and the area as a whole in response to terms-of-trade shocks under four monetary policy rules: fully optimal, optimal inflation targeting, HICP targeting and output gap stabilization. JEL Classification: E52, E58

Suggested Citation

  • Benigno, Pierpaolo & López-Salido, David, 2002. "Inflation persistence and optimal monetary policy in the euro area," Working Paper Series 0178, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20020178
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    References listed on IDEAS

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    More about this item

    Keywords

    currency areas; Inflation Dynamics; optimal monetary policy;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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