Keywords: Monetary policy, disinflation, sacrifice ratio, signal extraction
Abstract: In this paper, we formulate a dynamic general equilibrium model with staggered nominal contracts, in which households and firms use optimal filtering to disentangle persistent and transitory shifts in the monetary policy rule. The calibrated model accounts quite well for the dynamics of output and inflation during the Volcker disinflation, and implies a sacrifice ratio very close to the estimated
value. Our approach indicates that inflation persistence and
substantial costs of disinflation can be generated in an
optimizing-agent framework, without relaxing the assumption of
rational expectations or relying on arbitrary modifications to the
aggregate supply relation.
Full paper (625 KB PDF)
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Last update: November 1, 2001