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Imperfect credibility and inflation persistence

  • Christopher J. Erceg
  • Andrew T. Levin

In this paper, we formulate a dynamic general equilibrium model with staggered nominal contracts, in which households and firms use optimal filtering to disentangle persistent and transitory shifts in the monetary policy rule. The calibrated model accounts quite well for the dynamics of output and inflation during the Volcker disinflation, and implies a sacrifice ratio very close to the estimated value. Our approach indicates that inflation persistence and substantial costs of disinflation can be generated in an optimizing-agent framework, without relaxing the assumption of rational expectations or relying on arbitrary modifications to the aggregate supply relation.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-45.

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Date of creation: 2001
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Handle: RePEc:fip:fedgfe:2001-45
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