Calvo Contracts - Optimal Indexation in General Equilibrium

Vo Phuong Mai Le and A. Patrick Minford

No E2007/8, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: Calvo contracts, which are the basis of the current generation of New Keynesian models, widely include indexation to general inflation. We argue that the indexing formula should be expected inflation rather than lagged inflation. This is likely to optimise the welfare of the representative agent in a general equilibrium model of the New Keynesian type. The economy's behaviour under rational indexation is similar to that of a New Classical model, with shocks producing an immediate fluctuation in both prices and output followed by a fairly rapid return to steady state. A monetary policy that targets the price level increases economic stability.

Keywords: Calvo contracts; general equilibrium; rational indexation (search for similar items in EconPapers)
JEL-codes: E42 F41 F42 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2007-03, Revised 2008-10
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Working Paper: Calvo Contracts - Optimal Indexation in General Equilibrium (2006)
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