Working Papers,
Lund University, Department of Economics

Abstract: This paper presents a model that pictures how inflation is determined in a decentralized market process where prices are set in both simultaneous and sequential contracts. Price setting is seen as a coordination game between the price setters of sequential contracts. An important property of the model is that inflation thus can be explained without any reference to the quantity of money.Following up the finding that inflation is determined in a coordination game, it is subsequently claimed that whenever inflation does not follow a random path, people do seem to follow some rule of thumb when predicting future price levels. In the last section of the paper, it is finally claimed that this rule is best understood as a focal point, and furthermore that the central banks provides the focal point for inflation in the western world today. Central banks could thus be shown to be able to influence inflation rates, although the quantity of money plays no part in this process.

Keywords: Central Banking; Focal Points; Inflation; Monetary Policy; Money; Quantity Theory

JEL-codes: C70; E31; E42; E43; E44; E51; E52; E58

19 pages, May 16, 2005

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