The Selection Effect and the Inflation-Output Variability Trade-off

Engin Kara

No 5664, CESifo Working Paper Series from CESifo

Abstract: It has been shown that extending the Calvo model to account for the heterogeneity in price stickiness suggested by the micro-evidence significantly improves the performance of the model. In the new model, price-changing firms are chosen disproportionately from sectors with more flexible prices. In this paper, I show that this selection effect significantly affects policy conclusions that arise from the model. In the new model, the level and the variability of inflation is higher than in the Calvo model with no selection effect. Attempting to lower inflation’s variability results in a significant increase output’s variability, without changing inflation’s variability much.

Keywords: DSGE models; selection effect; variance trade-off; Multiple Calvo; Calvo (search for similar items in EconPapers)
JEL-codes: E00 (search for similar items in EconPapers)
Date: 2015
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