Downward Nominal Rigidity and Monetary Policy
Bank of England Working Paper No. 82
67 Pages Posted: 15 Sep 1998
Date Written: 1998
Abstract
This paper addresses the question of whether there is downward rigidity in money wages and prices. It is an issue that is relevant to the choice of the level of the inflation target, as it has been argued that targeting too low a level of inflation will be harmful when downward rigidities exist. The existence of such rigidities is questioned from a theoretical perspective on the basis of the very strict conditions that would have to apply. Also it is argued that concern for "fairness" or the presence of "money illusion" do not in themselves justify positive inflation. Empirical evidence is investigated, and it is found that the existence of downward rigidities is not proven.
This paper tests for unbiasedness in inflation expectations drawn from a survey of UK employees by Gallup. It focuses on the econometric difficulties presented by having a small sample, there being overlapping forecast horizons and by trying to make inference when the data appear to be non-stationary. Applying a method of inference suggested by Inder (1993) the paper concludes that measured expectations systematically overstate inflation. The paper checks the robustness of this result by looking at alternative survey data and by using alternative techniques for modelling the long run.
JEL Classification: E31
Suggested Citation: Suggested Citation
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