Disinflation Effects in a Medium-Scale New Keynesian Model: Money Supply Rule Versus Interest Rate Rule
University of Pavia
Bank of Italy
April 27, 2012
Bank of Italy Temi di Discussione (Working Paper) No. 867
Empirical studies show that successful disinflations entail a period of output contraction. Using a medium-scale New Keynesian model, we compare the effects of disinflations of different speed and timing, implemented through either a money supply or an interest rate rule. In terms of transitional output loss, cold-turkey disinflations under an interest rate rule are less costly than those under a money supply rule and are accomplished more rapidly. Furthermore, gradual or anticipated disinflations deliver lower sacrifice ratios. From a welfare perspective, despite the transitional economic contraction, disinflations are overall welfare-improving. Interestingly, the overall welfare gain is not affected by how the disinflation is actually implemented: what really matters is the achievement of a permanently lower inflation rate.
Number of Pages in PDF File: 57
Keywords: disinflation, sacrifice ratio, nonlinearities
JEL Classification: E31, E5working papers series
Date posted: May 15, 2012
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