Nominal Exchange Rate Anchoring Under Inflation Inertia
IMF Working Papers, February 1, 2002
Source details
- Canonical URL
- Nominal Exchange Rate Anchoring Under Inflation Inertia
Other formats
Bibliographic details
- Authors: Guillermo Calvo, Michael Kumhof, Oya Celasun
- Published: February 1, 2002
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451844924.001
Overview
- Title: Nominal Exchange Rate Anchoring Under Inflation Inertia
- Authors: Guillermo Calvo, Michael Kumhof, Oya Celasun
- Date: February 1, 2002
- Series: Working Paper No. 2002/030
- Issue: 030
- Pages: 36
- DOI: https://doi.org/10.5089/9781451844924.001
- ISBN: 9781451844924
- ISSN: 1018-5941
- Subject keywords included: Consumption, Exchange rates, Foreign exchange, Inflation, National accounts, Prices, Real exchange rates, Sticky prices
- Additional keywords listed: 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
Main findings
- The 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.
- These transitions are associated with significant output losses in nontradables.
- There is a welfare trade-off between output losses from the transition and the gains from smaller inflationary distortions.
- For most calibrations analyzed, the gains from lower inflation exceed the output losses.
- The optimal steady state identified is the Friedman rule.
Model and mechanisms
- Core mechanism: forward looking staggered price setting in the nontradable goods sector drives inflation inertia.
- Key implication: credibility alone does not imply instantaneous adjustment to a lower steady state inflation rate; adjustment is gradual and costly in output terms for nontradables.
- The analysis contrasts with other sticky-price theories by highlighting persistent transitional dynamics even under full credibility.
Welfare trade-offs and policy implications
- Welfare trade-off:
- Costs: Significant output losses in nontradables during transition to lower inflation.
- Benefits: Reduced inflationary distortions in steady state.
- Quantitative evaluation: Gains exceed losses for most calibrations used in the paper.
- Policy conclusion: The Friedman rule emerges as the optimal steady state policy in the framework developed.
Publication and access notes
- Publication title: IMF Working Papers
- Series metadata: Volume: 2002; Stock No: WPIEA0302002
- The working paper carries the standard disclaimer that it should not be reported as representing the views of the IMF; the views expressed are those of the author(s) and do not necessarily represent those of the IMF or IMF policy.
Nominal Exchange Rate Anchoring Under Inflation Inertia — IMF Working Paper No. 2002/030
Content in this bundle
- Nominal Exchange Rate Anchoring Under Inflation Inertia - WP/02/30