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PRICING POLICIES AND INFLATION DYNAMICS

Luis Cespedes (), Michael Kumhof () and Eric Parrado ()

Macroeconomic Dynamics, 2012, vol. 16, issue 4, 576-604

Abstract: The paper proposes a New Keynesian monetary model where firms' pricing policies feature a forward-looking optimal choice of the rate of price growth. The model can be thought of as a reduced form model of rational inattention that has only one additional state variable relative to the Calvo model [Journal of Monetary Economics 12 (1983), 383–398]. Like the model of backward-looking automatic indexation to past aggregate inflation, it generates a gradual and persistent reaction of the inflation rate, and output losses, following highly persistent monetary shocks. But unlike that model, its price setters behave very similarly to Calvo price setters when shocks are transitory.

Date: 2012
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