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Disinflation and Inequality in a DSGE monetary model: A Welfare Analysis

Listed author(s):
  • Maria Ferrara
  • Patrizio Tirelli

We investigate the redistributive e¤ects of a disinflation experiment in an otherwise standard medium-scale DSGE model augmented for Limited Asset Market Participation, implying that a fraction of households do not hold any wealth. We highlight two key mechanisms driving consumption and income distribution: i) the cash in advance constraint on firms working capital needs; ii) the response of profit margins to disinflation, which is crucially dependent on the two most used pricing assumptions in the New-Keynesian literature, i.e. Calvo vs Rotemberg. Results show that disinflation softens the cash in advance constraint and raises the real wage in steady state. This, in turn, lowers inequality. While under the Calvo formalism this e¤ect is reinforced by the fall of price markups, under Rotemberg it is more than compensated by the increase of price markups and, therefore, the opposite result obtains.

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File URL: http://dems.unimib.it/repec/pdf/mibwpaper305.pdf
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Paper provided by University of Milano-Bicocca, Department of Economics in its series Working Papers with number 305.

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Length: 35
Date of creation: Jul 2015
Date of revision: Jul 2015
Handle: RePEc:mib:wpaper:305
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  12. repec:fth:harver:1435 is not listed on IDEAS
  13. Hofmann, Boris & Peersman, Gert & Straub, Roland, 2012. "Time variation in U.S. wage dynamics," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 769-783.
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  17. Olivier Coibion & Yuriy Gorodnichenko & Lorenz Kueng & John Silvia, 2012. "Innocent Bystanders? Monetary Policy and Inequality in the U.S," NBER Working Papers 18170, National Bureau of Economic Research, Inc.
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  19. Lombardo, Giovanni & Vestin, David, 2008. "Welfare implications of Calvo vs. Rotemberg-pricing assumptions," Economics Letters, Elsevier, vol. 100(2), pages 275-279, August.
  20. Danziger, Leif, 1988. "Costs of Price Adjustment and the Welfare Economics of Inflation and Disinflation," American Economic Review, American Economic Association, vol. 78(4), pages 633-646, September.
  21. Julio Rotemberg, 1987. "The New Keynesian Microfoundations," NBER Chapters,in: NBER Macroeconomics Annual 1987, Volume 2, pages 69-116 National Bureau of Economic Research, Inc.
  22. Rabanal, Pau, 2007. "Does inflation increase after a monetary policy tightening? Answers based on an estimated DSGE model," Journal of Economic Dynamics and Control, Elsevier, vol. 31(3), pages 906-937, March.
  23. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
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