Working Paper: NBER ID: w9557
Authors: Guillermo Calvo; Oya Celasun; Michael Kumhof
Abstract: 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
Keywords: inflation inertia; disinflation; monetary policy; open economy
JEL Codes: E31; E52; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| credible disinflation policies (E31) | significant output losses (E23) |
| inflation inertia (E31) | significant output losses (E23) |
| historical pricing decisions (L11) | inflation inertia (E31) |
| behavior of new price setters (D41) | inflation inertia (E31) |
| inflation inertia (E31) | recession (E32) |
| initial pricing decisions (L11) | inflation inertia (E31) |
| front-loading behavior of firms (D22) | inflation inertia (E31) |