Calvo Contracts - Optimal Indexation in General Equilibrium

48 Pages Posted: 5 Jul 2006

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: April 2006

Abstract

Calvo contracts, which are the basis of the current generation of New Keynesian models, widely include indexation to general inflation. We argue that the indexing formula should be expected inflation rather than lagged inflation. This optimises the welfare of the representative agent in a general equilibrium model of the New Keynesian type. This is shown analytically for a simplified model and by numerical simulation for a full model with price and wage contracts as well as capital. The consequence of such indexation is that monetary policy no longer has any effect on welfare.

Keywords: New Keynesian, Calvo contracts, indexing

JEL Classification: E0

Suggested Citation

Le, Vo Phuong Mai and Minford, Patrick, Calvo Contracts - Optimal Indexation in General Equilibrium (April 2006). CEPR Discussion Paper No. 5616. Available at SSRN: https://ssrn.com/abstract=913381

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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