Learning, Endogenous Indexation and Disinflation in the New-Keynesian Model

Volker Wieland

No 6749, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper introduces adaptive learning and endogenous indexation in the New-Keynesian Phillips curve and studies disinflation under inflation targeting policies. The analysis is motivated by the disinflation performance of many inflation-targeting countries, in particular the gradual Chilean disinflation with temporary annual targets. At the start of the disinflation episode price-setting firms' expect inflation to be highly persistent and opt for backward-looking indexation. As the central bank acts to bring inflation under control, price-setting firms revise their estimates of the degree of persistence. Such adaptive learning lowers the cost of disinflation. This reduction can be exploited by a gradual approach to disinflation. Firms that choose the rate for indexation also re-assess the likelihood that announced inflation targets determine steady-state inflation and adjust indexation of contracts accordingly. A strategy of announcing and pursuing short-term targets for inflation is found to influence the likelihood that firms switch from backward-looking indexation to the central bank's targets. As firms abandon backward-looking indexation the costs of disinflation decline further. We show that an inflation targeting strategy that employs temporary targets can benefit from lower disinflation costs due to the reduction in backward-looking indexation.

Keywords: Disinflation; Indexation; Inflation targeting; Learning; Monetary policy; New-keynesian model; Recursive least squares (search for similar items in EconPapers)
JEL-codes: E32 E41 E43 E52 E58 (search for similar items in EconPapers)
Date: 2008-03
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Related works:
Chapter: Learning, Endogenous Indexation, and Disinflation in the New-Keynesian Model (2009)
Journal Article: Learning, Endogenous Indexation, and Disinflation in the New-Keynesian Model (2008)
Working Paper: Learning, Endogenous Indexation, and Disinflation in the New-Keynesian Model (2008)
Working Paper: Learning, endogenous indexation and disinflation in the New-Keynesian model (2008)
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