Models of Inflation and the Costs of Disinflation

IMF Working Papers, October 1, 1991

Source details

Focus: the output costs of disinflation.
Core modeling result: a model of inflation with both forward and backward elements seems to characterize reality.
Estimation: such an inflation model is estimated using data for industrial countries.
Output-cost calculation: the output costs of a disinflation path are calculated:
- analytically in a simple theoretical model, and
- by simulation of a global, multi-region empirical model.
Credibility of policies considered:
- the credibility of a preannounced path for money consistent with the lowest output loss is examined, and
- an alternative, more credible policy may be to announce an exchange rate peg to a low inflation currency.

Model features:
- inflation specification includes both forward and backward elements (forward-looking and backward-looking components).
Empirical approach:
- estimated using data for industrial countries.
- simulations performed with a global, multi-region empirical model to compute output costs of disinflation paths.
Analytical approach:
- a simple theoretical model is used to derive analytic expressions for output costs under disinflation.

Preannounced monetary paths:
- A preannounced path for money that minimizes output loss is analyzed, but its credibility is a concern.
Exchange rate peg:
- Announcing an exchange rate peg to a low inflation currency is presented as an alternative policy that may be more credible and help achieve disinflation with lower output costs.

Subject: Capacity utilization, Demand for money, Disinflation, Inflation, Monetary base, Money, Prices, Production
Keywords: Capacity utilization, Demand for money, Disinflation, disinflation path, disinflation program, Europe, Inflation, inflation equation, inflation stickiness, Monetary base, money supply, nominal interest rate, North America, Phased-in disinflation, price level, rate of inflation, WP