THE OUTPUT EFFECT OF STOPPING INFLATION WHEN VELOCITY IS TIME VARYING

Lynne Evans and Anamaria Nicolae
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Lynne Evans: Newcastle University Business School
Anamaria Nicolae: Durham University Business School

Romanian Economic Business Review, 2008, vol. 3, issue 2, 60-77

Abstract: This paper explores the role of time varying velocity on output responses to policies for reducing/stopping inflation. We study a dynamic general equilibrium model with sticky prices in which we introduce time varying velocity. Specifically, nonstationary velocity is endogenised in the model developed by Ireland (1997) for analysing optimal disinflation. The non-linear solution method reveals that, depending on velocity, the ‘disinflationary boom’ found by Ball (1994) may disappear and that early output losses may be much larger than previously thought. Indeed, we find that a gradual disinflation from a low inflation may even be undesirable given its overall negative impact on the economy.

Keywords: price stability; velocity; disinflation; output boom; optimal speed of disinflation (search for similar items in EconPapers)
Date: 2008
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