Nominal Exchange Rate Anchoring Under Inflation Inertia

ByGuillermo Calvo, Michael Kumhof, Oya Celasun

February 1, 2002

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Consumption, Exchange rates, Foreign exchange, Inflation, National accounts, Prices, Real exchange rates, Sticky prices

Keywords: Consumption, emerging market, exchange rate based stabilization, Exchange rates, Inflation, Inflation inertia, inflation stabilization, open economy, price level, rate depreciation, rate of exchange, Real exchange rates, staggered pricing, Sticky prices, WP

Pages:
36
Volume:
2002
DOI:
https://doi.org/10.5089/9781451844924.001
Issue:
030
Series:
Working Paper No. 2002/030
Stock No:
WPIEA0302002
ISBN:
9781451844924
ISSN:
1018-5941

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