Essay About Mail Stop And Version Of A Canonical Sticky-Price Model

Monetary Policy and Inflation
Join now to read essay 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 banks 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 eects 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 eects of monetary policy.
Corresponding author. Mailing address: Mail Stop 80, 20th and C Streets NW, Washington, DC 20551.
E-mail: [email protected].
E-mail: [email protected]. 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 aects 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 model
have typically been restricted to contexts in which the central bank maintains a xed infla-
tion target, with particular attention being paid to the eects of the type of monetary policy
shock” that is usually analyzed in the empirical VAR literature (namely, a temporary de-
viation from a stable policy rule). In this paper, we present a re-formulated version of the
baseline sticky-price model that has been extended to account for variations over time in
the central banks inflation target. We derive a fully specied closed-form solution for the
model in which output and inflation are related both to policy shocks (as usually dened)
and to expected future changes in the inflation target. The model provides a simple but
flexible framework for understanding a number of issues that have previously been dealt
with using a range of dierent specications. In particular, the model sheds light on some
important existing critiques regarding the general ability of sticky-price models to capture
the eects of disinflationary monetary policies.
One such critique that we consider stems from Laurence Balls (1994) well-known ex-
ample of a sticky-price economy in which an announcement of a gradual reduction in the
rate of growth of the money supply results in a boom in output. This has commonly