Monopolistic Competition, Credibility and the Output Costs of Disinflation Programs: An Analysis of Price Controls
Brazil, Argentina and Israel all used price controls as part of disinflation programs in 1985-1986. In each case they were intended to break an "inertial" component of inflation. This paper focuses on a specific mechanism through which inflation inertia can emerge: the interaction between lack of credibility of government monetary policy announcements and the price setting behavior of forward looking firms. We show that this interaction can lead to inertia extending well beyond the price setting period; that is important since the price setting period is likely to be short in high inflation economies. We develop an open economy macromodel in which firms set prices before uncertainty about government monetary policy is resolved. Lack of credibility is then shown to lead to output losses during a disinflation program. We demonstrate the effects of price controls and show that their temporary use can be defended on welfare grounds. The paper analyzes asset price behavior during disinflation programs with and without price controls and the influence of credibility problems. We discuss nominal and real interest rates, the stock market and exchange rates. Finally we show that if past government policy has any information content about future government policy, cheating on current announcements of tight policy buys current employment gains during the price control period at the cost of higher inflation afterwards. Sustaining low inflation after the price control period thus requires restrictive monetary policy during the price control period.
|Date of creation:||Jun 1987|
|Publication status:||published as van Wijnbergen, Sweder. "Monopolistic Competition, Credibility and the Output Costs of Disinflation Programs: An Analysis of Price Controls." Journal of Development Economics, Vol. 29, no. 3, (November 1988): pp. 375-398.|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Backus, David & Driffill, John, 1985.
"Inflation and Reputation,"
American Economic Review,
American Economic Association, vol. 75(3), pages 530-538, June.
- Helpman, Elhanan & Razin, Assaf, 1984. "The role of saving and investment in exchange rate determination under alternative monetary mechanisms," Journal of Monetary Economics, Elsevier, vol. 13(3), pages 307-325, May.
- David Kreps & Robert Wilson, 1999.
"Reputation and Imperfect Information,"
Levine's Working Paper Archive
238, David K. Levine.
- Persio Arida & André Lara Resende, 1985. "Inertial inflation and monetary reform in Brazil," Textos para discussão 85, Department of Economics PUC-Rio (Brazil).
- Frenkel, Jacob A & Razin, Assaf, 1985. "Government Spending, Debt, and International Economic Interdependence," Economic Journal, Royal Economic Society, vol. 95(379), pages 619-636, September.
- David Backus & John Driffill, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Oxford University Press, vol. 52(2), pages 211-221.
- Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
- Robert J. Barro, 1986.
"Reputation in a Model of Monetary Policy with Incomplete Information,"
NBER Working Papers
1794, National Bureau of Economic Research, Inc.
- Barro, Robert J., 1986. "Reputation in a model of monetary policy with incomplete information," Journal of Monetary Economics, Elsevier, vol. 17(1), pages 3-20, January.
- Lars E. O. Svensson, 1986. "Sticky Goods Prices, Flexible Asset Prices, Monopolistic Competition, and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 53(3), pages 385-405.
- Barro, Robert J, 1986. "Recent Developments in the Theory of Rules versus Discretion," Economic Journal, Royal Economic Society, vol. 96(380a), pages 23-37, Supplemen.
- Joshua Aizenman, 1986.
"Monopolistic Competition, Relative Prices and Output Adjustment in the Open Economy,"
NBER Working Papers
1787, National Bureau of Economic Research, Inc.
- Aizenman, Joshua, 1989. "Monopolistic competition, relative prices, and output adjustment in the open economy," Journal of International Money and Finance, Elsevier, vol. 8(1), pages 5-28, March.
- Torsten Persson & Sweder van Wijnbergen, 1989.
"Signalling, Wage Controls and Monetary Disinflation Policy,"
NBER Working Papers
2939, National Bureau of Economic Research, Inc.
- Persson, Torsten & van Wijnbergen, Sweder, 1993. "Signalling, Wage Controls and Monetary Disinflation Policy," Economic Journal, Royal Economic Society, vol. 103(416), pages 79-97, January.
- Dixit, Avinash K & Stiglitz, Joseph E, 1975.
"Monopolistic Competition and Optimum Product Diversity,"
The Warwick Economics Research Paper Series (TWERPS)
64, University of Warwick, Department of Economics.
- Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
- Lawrence H. Summers, 1985. "Issues in National Savings Policy," NBER Working Papers 1710, National Bureau of Economic Research, Inc.
- Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-1445, November.
- Svensson, Lars E. O., 1985. "Currency prices, terms of trade, and interest rates: A general equilibrium asset-pricing cash-in-advance approach," Journal of International Economics, Elsevier, vol. 18(1-2), pages 17-41, February.
- Horn, Henrik & Persson, Torsten, 1988. "Exchange rate policy, wage formation and credibility," European Economic Review, Elsevier, vol. 32(8), pages 1621-1636, October.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:2302. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.