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Inflation Inertia and Credible Disinflation - The Open Economy Case

  • Guillermo Calvo
  • Oya Celasun
  • Michael Kumhof

This paper develops a model of inflation inertia based on optimizing forward looking staggered price setting in a small open economy. Unlike in current models 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. There is a welfare trade-off between these output losses and the gains from smaller inflationary distortions. For reasonable parameter values inflation stabilization improves welfare. The optimal steady state is reached at the Friedman rule. Technical appendices are available at www.nber.org/data-appendix/w9557/ inert-techapp.pdf

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File URL: http://www.nber.org/papers/w9557.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9557.

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Date of creation: Mar 2003
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Publication status: published as Calvo, Guillermo, O. Celasun and M. Kumhof. “Inflation Inertia and Credible Disinflation – The Open Economy Case." Journal of International Economics (2007).
Handle: RePEc:nbr:nberwo:9557
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