## Nominal Exchange Rate Anchoring Under Inflation Inertia

_IMF Working Papers, February 1, 2002_

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## 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

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### 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*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/30/nominal-exchange-rate-anchoring-under-inflation-inertia-15617_