Abstract

http://ssrn.com/abstract=1141654
 
 

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Learning, Endogenous Indexation and Disinflation in the New-Keynesian Model


Volker Wieland


University of Frankfurt

March 1, 2008

CEPR Discussion Paper No. DP6749

Abstract:     
This paper introduces adaptive learning and endogenous indexation in the New-Keynesian Phillips curve and studies disinflation under inflation targeting policies. The analysis is motivated by the disinflation performance of many inflation-targeting countries, in particular the gradual Chilean disinflation with temporary annual targets. At the start of the disinflation episode price-setting firms' expect inflation to be highly persistent and opt for backward-looking indexation. As the central bank acts to bring inflation under control, price-setting firms revise their estimates of the degree of persistence. Such adaptive learning lowers the cost of disinflation. This reduction can be exploited by a gradual approach to disinflation. Firms that choose the rate for indexation also re-assess the likelihood that announced inflation targets determine steady-state inflation and adjust indexation of contracts accordingly. A strategy of announcing and pursuing short-term targets for inflation is found to influence the likelihood that firms switch from backward-looking indexation to the central bank's targets. As firms abandon backward-looking indexation the costs of disinflation decline further. We show that an inflation targeting strategy that employs temporary targets can benefit from lower disinflation costs due to the reduction in backward-looking indexation.

Number of Pages in PDF File: 35

Keywords: disinflation, indexation, inflation targeting, learning, monetary policy, New-Keynesian model, recursive least squares

JEL Classification: E32, E41, E43, E52, E58

working papers series





Date posted: June 10, 2008  

Suggested Citation

Wieland, Volker, Learning, Endogenous Indexation and Disinflation in the New-Keynesian Model (March 1, 2008). , Vol. , pp. -, 2008. Available at SSRN: http://ssrn.com/abstract=1141654

Contact Information

Volker Wieland (Contact Author)
University of Frankfurt ( email )
House of Finance
Grüneburgplatz 1
Frankfurt am Main, D-60323
Germany
+49 69 798 33805 (Phone)
+49 69 798 33907 (Fax)
HOME PAGE: http://www.volkerwieland.com
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