Optimising Indexation Arrangements under Calvo Contracts and Their Implications for Monetary Policy

23 Pages Posted: 23 May 2008

See all articles by Vo Phuong Mai Le

Vo Phuong Mai Le

Cardiff University - Cardiff Business School

Patrick Minford

Cardiff University Business School; Centre for Economic Policy Research (CEPR)

Date Written: June 2007

Abstract

This paper investigates optimal indexation in the New Keynesian model, when the indexation choice includes the possibility of partial indexation and of varying weights on rational and lagged indexation. It finds that the Calvo contract adjusted for rationally expected indexation under both inflation and price level targeting regimes delivers the highest expected welfare under both restricted and full current information. Rational indexation eliminates the effectiveness of monetary policy on welfare when there is only price-level targeting under the current micro information. If including both wage setting and full current information, monetary policy is effective; and a price-level targeting rule delivers the highest benefits because it minimises the size of shocks to prices and thus dispersion. However, even less than full rational indexation ensures that there is very little nominal rigidity in the adapted world of Calvo contracts.

Keywords: Calvo contracts, inflation target, New Keynesian model, optimal indexation, price-level target, rational expectation

JEL Classification: E50, E52

Suggested Citation

Le, Vo Phuong Mai and Minford, Patrick, Optimising Indexation Arrangements under Calvo Contracts and Their Implications for Monetary Policy (June 2007). CEPR Discussion Paper No. DP6325. Available at SSRN: https://ssrn.com/abstract=1136651

Vo Phuong Mai Le

Cardiff University - Cardiff Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom

Patrick Minford (Contact Author)

Cardiff University Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom
+44 29 2087 5728 (Phone)
+44 29 2087 4419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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