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Partial inflation indexation and long-run inflation targeting in a growing economy : a comparison of Calvo and Rotemberg pricing models.

Basu, P. and Sarkar, A. (2016) 'Partial inflation indexation and long-run inflation targeting in a growing economy : a comparison of Calvo and Rotemberg pricing models.', Journal of macroeconomics., 50 . pp. 293-306.

Abstract

The observed 2% long run inflation target in most developed industrial nations is in variance with the zero or negative optimal inflation rates predicted by prominent monetary theories. Using a calibrated simple New-Keynesian model with endogenous growth and nominal rigidity, we compare two price setting environments of Calvo (1983) and Rotemberg (1982). In our growth model, the steady state welfare maximizing inflation takes into account the growth effect as well as the price distortionary effects of inflation. The long-run welfare maximizing trend inflation could be positive in economies with nominal rigidity in the form of partial inflation indexation and price stickiness. A higher degree of inflation indexation lowers the steady state price distortion in the Calvo model and steady state price adjustment cost in Rotemberg model and raises the long run optimal inflation. Since the productive inefficiency caused by partial inflation indexation is higher in Calvo economy compared to Rotemberg, the long run optimal trend inflation is higher in Rotemberg than in Calvo. In both models, a two percent long run inflation target is attainable for a reasonable degree of inflation indexation.

Item Type:Article
Full text:(AM) Accepted Manuscript
First Live Deposit - 21 October 2016
Available under License - Creative Commons Attribution Non-commercial No Derivatives.
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Status:Peer-reviewed
Publisher Web site:http://dx.doi.org/10.1016/j.jmacro.2016.10.001
Publisher statement:© 2016. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/
Record Created:21 Oct 2016 11:35
Last Modified:22 Oct 2017 00:53

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