How Costly is CPI Inflation Targeting: A Two Sector Model with No Labor Mobility

Onmus-Baykal Elif ()
Additional contact information
Onmus-Baykal Elif: Georgetown University

The B.E. Journal of Macroeconomics, 2011, vol. 11, issue 1, 32

Abstract: This paper studies the welfare costs of price rigidities in a closed economy without labor mobility. First, in a one-sector model, I find a significant welfare cost of price rigidities under a standard Taylor rule, especially when labor is immobile. In the one-sector model, strict CPI inflation targeting is able to eliminate the welfare cost of price rigidities, with or without labor mobility. Then, I develop a vertically integrated two-sector model with nominal and real rigidities where there is a natural distinction between the rates of inflation in the final and intermediate goods sectors. In the two-sector model, the real rigidities are introduced by assuming that labor is immobile across sectors and firms. In the model, labor immobility plays an allocative role and causes large fluctuations in hours of work. This, in turn, magnifies the welfare costs of nominal rigidities. I find that the welfare costs range from 1.62 percent to 2.33 percent of consumption per period for different degree of price rigidities under an estimated Taylor rule over the Volcker and Greenspan years. Taking the household welfare under optimal (Ramsey) monetary policy as a benchmark, I show that an optimal modified Taylor rule with two measures of inflation is able to bring welfare closer to the benchmark value and reduces the welfare costs substantially, even if labor mobility is restricted.

Keywords: vertically integrated two-sector model; labor immobility; inflation targeting (search for similar items in EconPapers)
Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://doi.org/10.2202/1935-1690.1950 (text/html)
For access to full text, subscription to the journal or payment for the individual article is required.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bpj:bejmac:v:11:y:2011:i:1:n:1

Ordering information: This journal article can be ordered from
https://www.degruyter.com/journal/key/bejm/html

DOI: 10.2202/1935-1690.1950

Access Statistics for this article

The B.E. Journal of Macroeconomics is currently edited by Arpad Abraham and Tiago Cavalcanti

More articles in The B.E. Journal of Macroeconomics from De Gruyter
Bibliographic data for series maintained by Peter Golla ().