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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Imperfect Credibility and Inflation Persistence
Christopher J. Erceg and Andrew T. Levin

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.

Keywords: Monetary policy, disinflation, sacrifice ratio, signal extraction

Full paper (625 KB PDF)

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Last update: November 1, 2001