NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

NBER Working Papers by Michael Kumhof

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Working Papers

March 2003Inflation Inertia and Credible Disinflation - The Open Economy Case
with Guillermo Calvo, Oya Celasun: w9557
This paper develops a model of inflation inertia based on optimizing forward looking staggered price setting in a small open economy. Unlike in current models 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. There is a welfare trade-off between these output losses and the gains from smaller inflationary distortions. For reasonable parameter values inflation stabilization improves welfare. The optimal steady state is reached at the Friedman rule. Technical appendices are available at www.nber.org/data-appendix/w9557/ inert-techapp.pdf

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