Working Paper: CEPR ID: DP3038
Authors: Willem H. Buiter; Clemens Grafe
Abstract: The Paper studies the design of efficient disinflation programmes in open economies using the sacrifice ratio; that is, the cumulative additional un-employment or cumulative lost output required to achieve a 1% sustained reduction in the rate of inflation, as the metric of efficiency. The ?new Keynesian? Phillips curve first proposed by Calvo has a zero sacrifice ratio: costless disinflation is possible, because the inflation process is purely forward-looking. There is inertia or rigidity in the price level but not in the rate of inflation. More interesting inflation kernels for which current inflation is partly forward-looking and partly backward-looking have a positive sacrifice ratio. Real exchange rate appreciation early in the disinflation process may raise the sacrifice ratio relative to a policy that keeps the real exchange rate constant. The sacrifice ratio is lower under gradualism than under ?cold turkey?. Effficient disinflation policies may, however, be time-inconsistent and therefore not credible.
Keywords: disinflation; new keynesian phillips curve; sacrifice ratio
JEL Codes: E31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| responsiveness of wage inflation to unemployment (J65) | sacrifice ratio (C79) |
| nature of core inflation process (E31) | sacrifice ratio (C79) |
| real exchange rate dynamics (F31) | sacrifice ratio (C79) |