Nominal Exchange Rate Anchoring Under Inflation Inertia

Author/Editor:

Guillermo Calvo ; Michael Kumhof ; Oya Celasun

Publication Date:

February 1, 2002

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper develops a theory of inflation inertia based on forward looking staggered price setting in the nontradable goods sector of a small open economy. Unlike current theories 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 in nontradables There is a welfare trade-off between these output losses and the gains from smaller inflationary distortions. Gains exceed losses for most calibrations. The optimal steady state is the Friedman rule.

Series:

Working Paper No. 2002/030

Subject:

Consumption Exchange rates Foreign exchange Inflation National accounts Prices Real exchange rates Sticky prices

English

Publication Date:

February 1, 2002

ISBN/ISSN:

9781451844924/1018-5941

Stock No:

WPIEA0302002

Pages:

36

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