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Trend inflation, the labor market wedge, and the non-vertical Phillips curve

  • Di Bartolomeo Giovanni
  • Tirelli Patrizio
  • Acocella Nicola

Recent developments in macroeconomics resurrect the view that welfare costs of inflation arise because the latter acts as a tax on money balances. Empirical contributions show that wage re-negotiations take place while expiring contracts are still in place. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we find a disciplining effect of a positive inflation target on the wage markup and identify a long-term trade-off between inflation and output. This has important policy implications, ranging from the opportunity of revising the target in response to shocks, to the possibility of exploiting inflation as a tool to increase tax revenues via its employment- enhancing effect.

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Paper provided by Department of Communication, University of Teramo in its series wp.comunite with number 0081.

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Date of creation: Oct 2011
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Handle: RePEc:ter:wpaper:0081
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