Nominal Exchange Rate Anchoring Under Inflation Inertia

Guillermo Calvo, Michael Kumhof and Oya Celasun

No 2002/030, IMF Working Papers from International Monetary Fund

Abstract: This paper develops a theory of inflation inertia based on forward looking staggered price setting in the nontradable goods sector of a small open economy. Unlike current theories of sticky prices, transitions to a lower steady state inflation rate take time even if they are fully credible, and they are associated with significant output losses in nontradables There is a welfare trade-off between these output losses and the gains from smaller inflationary distortions. Gains exceed losses for most calibrations. The optimal steady state is the Friedman rule.

Keywords: WP; rate of exchange; emerging market; Inflation inertia; staggered pricing; exchange rate based stabilization; rate depreciation; price level; inflation stabilization; open economy; Inflation; Sticky prices; Exchange rates; Consumption; Real exchange rates (search for similar items in EconPapers)
Pages: 36
Date: 2002-02-01
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Citations: View citations in EconPapers (10)

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