Monetary Policy and Inflation
Inflation Targets, Credibility, and Persistence
In a Simple Sticky-Price Framework
Jeremy Rudd
Federal Reserve Board
Karl Whelan
Central Bank of Ireland
July 23, 2003
Abstract
This paper presents a re-formulated version of a canonical sticky-price model that has been extended to account for variations over time in the central bank 's inflation tar- get. We derive a closed-form solution for the model, and analyze its properties under various parameter values. The model is used to explore topics relating to the e ects of disinflationary monetary policies and inflation persistence. In particular, we employ the model to illustrate and assess the critique that standard sticky-price models generate counterfactual predictions for the e ects of monetary policy.
Corresponding author. Mailing address: Mail Stop 80, 20th and C Streets NW, Washington, DC 20551.
E-mail: jeremy.b.rudd@frb.gov.
E-mail: karl.whelan@centralbank.ie. We thank Gregory Mankiw and Olivier Blanchard for useful dis- cussions on several of the topics considered here. The views expressed in this paper are our own, and do not necessarily reflect the views of the Board of Governors, the sta of the Federal Reserve System, or the
Central Bank of Ireland.
1 Introduction
An important trend in macroeconomic research in recent years involves the increased use of optimization-based sticky-price models to analyze how monetary policy a ects the econ- omy and how optimal policy should be designed. Much of this analysis employs a simple baseline model that features a \new-Keynesian" Phillips curve to characterize inflation, an
\expectational IS curve" to determine output growth, and a policy rule that describes how the central bank sets short-term interest rates; representative examples of studies that use this framework include Clarida, Gal, and Gertler (1999), McCallum (2001), and Wood- ford (2003).
One limitation of existing work in this area is that applications of the baseline
In a Simple Sticky-Price Framework
Jeremy Rudd
Federal Reserve Board
Karl Whelan
Central Bank of Ireland
July 23, 2003
Abstract
This paper presents a re-formulated version of a canonical sticky-price model that has been extended to account for variations over time in the central bank 's inflation tar- get. We derive a closed-form solution for the model, and analyze its properties under various parameter values. The model is used to explore topics relating to the e ects of disinflationary monetary policies and inflation persistence. In particular, we employ the model to illustrate and assess the critique that standard sticky-price models generate counterfactual predictions for the e ects of monetary policy.
Corresponding author. Mailing address: Mail Stop 80, 20th and C Streets NW, Washington, DC 20551.
E-mail: jeremy.b.rudd@frb.gov.
E-mail: karl.whelan@centralbank.ie. We thank Gregory Mankiw and Olivier Blanchard for useful dis- cussions on several of the topics considered here. The views expressed in this paper are our own, and do not necessarily reflect the views of the Board of Governors, the sta of the Federal Reserve System, or the
Central Bank of Ireland.
1 Introduction
An important trend in macroeconomic research in recent years involves the increased use of optimization-based sticky-price models to analyze how monetary policy a ects the econ- omy and how optimal policy should be designed. Much of this analysis employs a simple baseline model that features a \new-Keynesian" Phillips curve to characterize inflation, an
\expectational IS curve" to determine output growth, and a policy rule that describes how the central bank sets short-term interest rates; representative examples of studies that use this framework include Clarida, Gal, and Gertler (1999), McCallum (2001), and Wood- ford (2003).
One limitation of existing work in this area is that applications of the baseline
References: [1] Ball, Laurence (1994). Credible Disinflation with Staggered Price Setting," American Economic Review, 84, 282-289. [2] Ball, Laurence (1995). Disinflation with Imperfect Credibility," Journal of Monetary Economics, 35, 5-23. [3] Bernanke, Ben and Mark Gertler (1995). Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, 9, 27-48. [4] Clarida, Richard, Jordi Gal , and Mark Gertler (1999). The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, 37, 1661- [5] Devereux, Michael and James Yetman (2003). Predetermined Prices and the Per- sistent E ects of Money on Output" (forthcoming, Journal of Money, Credit, and [6] Erceg, Christopher and Andrew Levin (2001). Imperfect Credibility and Inflation Persistence," Federal Reserve Board Finance and Economics Discussion Series, 2001- [8] McCallum, Bennett (2001). Should Monetary Policy Respond Strongly to Output Gaps?" American Economic Review, 91, 258-262. [9] Pivetta, Frederic, and Ricardo Reis (2003). The Persistence of Inflation in the United States," mimeo, Harvard University (March). [10] Stock, James (2001). Comment" on Cogley and Sargent, NBER Macroeconomics Annual 2001, 379-387. [11] Walsh, Carl (1998). Monetary Theory and Policy, Cambridge: MIT Press. [12] Whelan, Karl (2002). A Guide to U.S. Chain Aggregated NIPA Data," Review of Income and Wealth, 48, 217-233. [13] Woodford, Michael (2003). Interest and Prices, Princeton: Princeton University Press.