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Nominal Exchange Rate Anchoring Under Inflation Inertia

  • Guillermo Calvo
  • Michael Kumhof
  • Oya Celasun

This paper develops a theory of inflation inertia based on forward looking staggered price setting in the nontradable goods sector of a small open economy. Unlike current theories of sticky prices, transitions to a lower steady state inflation rate take time even if they are fully credible, and they are associated with significant output losses in nontradables There is a welfare trade-off between these output losses and the gains from smaller inflationary distortions. Gains exceed losses for most calibrations. The optimal steady state is the Friedman rule.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 02/30.

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Length: 36
Date of creation: 01 Feb 2002
Date of revision:
Handle: RePEc:imf:imfwpa:02/30
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  8. Laurence Ball, 1993. "What Determines the Sacrifice Ratio?," NBER Working Papers 4306, National Bureau of Economic Research, Inc.
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  20. Calvo, Guillermo A, 1986. "Temporary Stabilization: Predetermined Exchange Rates," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1319-29, December.
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  24. Kamin, Steven B., 2001. "Real exchange rates and inflation in exchange-rate-based stabilizations: an empirical examination," Journal of Development Economics, Elsevier, vol. 64(1), pages 237-253, February.
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  27. Menon, Jayant, 1995. " Exchange Rate Pass-Through," Journal of Economic Surveys, Wiley Blackwell, vol. 9(2), pages 197-231, June.
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