The gain from commitment in a two-country economy with inflation persistence

Daisuke Ida

Japan and the World Economy, 2013, vol. 27, issue C, 58-69

Abstract: In recent years, the worldwide inflation rate appears to be converging to a low stable level. Moreover, the Phillips curve is flattening in many countries. These facts indicate that the output gap fluctuations associated with inflation persistence in one country influence other countries and suggest that the central bank consider the effect of inflation persistence on the real economy in an open economy framework. The objective of this paper is to explore optimal monetary policy in a two-country economy with inflation persistence. To consider the case in which inflation persistence is present in both countries, we assume that a fraction of firms that change their prices follows the rule-of-thumb pricing rule. In this case, the new Keynesian Phillips curve (NKPC) in each country becomes flatter as the fraction of firms employing the rule-of-thumb pricing rule increases in both countries. Our results show gains from commitment in a two-country economy with inflation persistence. This paper addresses that the presence of a severe deflationary bias is the main source of the large gain from a commitment policy in a two-country economy with inflation persistence.

Keywords: Inflation persistence; Optimal monetary policy; Terms of trade externality; Deflationary bias; Two-country model (search for similar items in EconPapers)
JEL-codes: E52 E58 F41 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:japwor:v:27:y:2013:i:c:p:58-69

DOI: 10.1016/j.japwor.2013.03.008

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