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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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  18. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters, in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc.
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