No Pain, No Gain? The Simple Analytics of Efficient Disinflation in Open Economies

35 Pages Posted: 20 Nov 2001

See all articles by Willem H. Buiter

Willem H. Buiter

Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Columbia University; Independent Economic Adviser; Independent

Clemens Grafe

University of London, Birkbeck College - Department of Economics

Date Written: November 2001

Abstract

The Paper studies the design of efficient disinflation programmes in open economies using the sacrifice ratio; that is, the cumulative additional un-employment or cumulative lost output required to achieve a 1% sustained reduction in the rate of inflation, as the metric of efficiency. The 'new Keynesian' Phillips curve first proposed by Calvo has a zero sacrifice ratio: costless disinflation is possible, because the inflation process is purely forward-looking. There is inertia or rigidity in the price level but not in the rate of inflation. More interesting inflation kernels for which current inflation is partly forward-looking and partly backward-looking have a positive sacrifice ratio. Real exchange rate appreciation early in the disinflation process may raise the sacrifice ratio relative to a policy that keeps the real exchange rate constant. The sacrifice ratio is lower under gradualism than under 'cold turkey'. Effficient disinflation policies may, however, be time-inconsistent and therefore not credible.

Keywords: Sacrifice ratio, disinflation, new Keynesian Phillips curve

JEL Classification: E31, F41

Suggested Citation

Buiter, Willem H. and Grafe, Clemens, No Pain, No Gain? The Simple Analytics of Efficient Disinflation in Open Economies (November 2001). Available at SSRN: https://ssrn.com/abstract=290395

Willem H. Buiter (Contact Author)

Centre for Economic Policy Research (CEPR)

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CESifo (Center for Economic Studies and Ifo Institute)

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Columbia University ( email )

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Clemens Grafe

University of London, Birkbeck College - Department of Economics ( email )

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