Tradeoffs Between Inflation and Output-Gap Variances in an Optimization-Agent Model

Christopher John Erceg, Dale W. Henderson and Andrew Theo Levin ()
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Dale W. Henderson: Division of International Finance of the Federal Reserve Board, Postal: Federal Reserve Board, Stop 24, Washington DC 20551, USA

No 650, Seminar Papers from Stockholm University, Institute for International Economic Studies

Abstract: We demonstrate the existence of a monetary policy tradeoff between price-inflation variability and output-gap variability in an optimizing-agent model with staggered nominal wage and price contracts. This variance tradeoff is absent only in the special case in which prices are sticky and wages are perfectly flexible. When the model is calibrated to exhibit an empirically reasonable degreee of nominal wage inertia, strict inflation targeting induces substantial output-gap volatility.

Keywords: monetary policy tradeoff; price-inflation variability; output-gap variability (search for similar items in EconPapers)
JEL-codes: E42 E52 (search for similar items in EconPapers)
Date: 1998-09-01

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