Designing linear inflation contracts in the New Keynesian model

Meixing Dai () and Marine André

Economics Bulletin, 2022, vol. 42, issue 4, 1782 - 1797

Abstract: This paper studies how to design linear inflation contracts to shape the incentive structure faced by the central bank in the New Keynesian model with positive optimal output gap and inflation target. Such contracts are known to be able to deal with the time-inconsistency problem in the Barro-Gordon framework, arising from incentives for the central bank to exploit the inflation-output trade-off induced by an “overambitious” output-gap target. We show that linear inflation contracts help reduce inflation undershooting and partially eliminate the inflation bias in the New Keynesian model. They are significantly different from those designed in the Barro-Gordon model.

Keywords: inflation bias; inflation contract; monetary policy delegation; optimal monetary policy (search for similar items in EconPapers)
JEL-codes: E5 (search for similar items in EconPapers)
Date: 2022-12-30
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