Scandinavian Working Papers in Economics
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Institute for International Economic Studies, Stockholm University Seminar Papers, Institute for International Economic Studies, Stockholm University

No 650:
Tradeoffs Between Inflation and Output-Gap Variances in an Optimizing-Agent Model

Christopher J. Erceg (), Dale W. Henderson and Andrew T. Levin

Abstract: We demonstrate the existence of a monetary policy tradeoff between price-inflation variability and output-gap variability in an optimizing-agent model with staggered nominal wage and price contracts. This variance tradeoff is absent only in the special case in which prices are sticky and wages are perfectly flexible. When the model is calibrated to exhibit an empirically reasonable degreee of nominal wage inertia, strict inflation targeting induces substantial output-gap volatility.

Keywords: monetary policy tradeoff; price-inflation variability; output-gap variability; (follow links to similar papers)

JEL-Codes: E42; E52; (follow links to similar papers)

41 pages, September 1, 1998

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