Tradeoffs between Inflation and Output-Gap Variances in an Optimizing-Agent Model

44 Pages Posted: 30 Jan 1999

See all articles by Christopher J. Erceg

Christopher J. Erceg

Board of Governors of the Federal Reserve System

Dale W. Henderson

Federal Reserve Board

Andrew T. Levin

affiliation not provided to SSRN

Date Written: October 1998

Abstract

We demonstrate the existence of a monetary policy tradeoff between price-inflation variability and output-gap variability in an optimizing-agent model with staggered nominal wage and price contracts. This variance tradeoff is absent only in the special case in which prices are sticky and wages are perfectly flexible. When the model is calibrated to exhibit an empirically reasonable degree of nominal wage inertia, strict inflation targeting induces substantial output-gap volatility.

JEL Classification: E52, E61

Suggested Citation

Erceg, Christopher J. and Henderson, Dale W. and Levin, Andrew, Tradeoffs between Inflation and Output-Gap Variances in an Optimizing-Agent Model (October 1998). Available at SSRN: https://ssrn.com/abstract=140318 or http://dx.doi.org/10.2139/ssrn.140318

Christopher J. Erceg (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Dale W. Henderson

Federal Reserve Board ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2343 (Phone)
202-736-5638 (Fax)

Andrew Levin

affiliation not provided to SSRN

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