Working Paper: CEPR ID: DP4288
Authors: Patrick Minford; David Peel
Abstract: The Calvo contract Phillips Curve is widely indexed for general inflation, using either core inflation or other backward-looking formulae. Such a Phillips Curve implies a high and persistent degree of nominal rigidity. It is argued here that optimal indexation would by contrast use the rational expectation of inflation. If this scheme is implemented, the relationship defaults to a familiar ?surprise? Phillips Curve, removing all except temporary monetary rigidity.
Keywords: Indexing; New Keynesian synthesis; Phillips curve; Price stickiness; Rational expectations
JEL Codes: E31; E32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Indexing the Calvo contract to expected inflation (E31) | Aligning the Phillips curve with the surprise Phillips curve (E31) |
| Aligning the Phillips curve with the surprise Phillips curve (E31) | Eliminating puzzles regarding nominal rigidity and time-inconsistency problem in monetary policy (C54) |
| Indexing the Calvo contract to expected inflation (E31) | More predictable and manageable relationship between inflation and output (E31) |