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Using a projection method to analyze inflation bias in a micro-founded model

Gary Anderson, Jinill Kim () and Tack Yun ()

No 2010-18, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)

Abstract: Since Kydland and Prescott (1977) and Barro and Gordon (1983), most studies of the problem of the inflation bias associated with discretionary monetary policy have assumed a quadratic loss function. We depart from the conventional linear-quadratic approach to the problem in favor of a projection method approach. We investigate the size of the inflation bias that arises in a microfounded nonlinear environment with Calvo price setting. The inflation bias is found to lie between 1% and 6% for a reasonable range of parameter values, when the bias is defined as the steady-state deviation of the discretionary inflation rate from the optimal inflation rate under commitment.

Keywords: Inflation (Finance); Econometric models (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2010
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