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OPTIMAL INFLATION TARGETING RULE UNDER POSITIVE HAZARD FUNCTIONS FOR PRICE CHANGES

Published online by Cambridge University Press:  19 September 2016

Giovanni Di Bartolomeo  and
Marco Di Pietro
Giovanni Di Bartolomeo*
Affiliation:
Sapienza University of Rome
Marco Di Pietro
Affiliation:
Sapienza University of Rome
*
Address correspondence to: Giovanni Di Bartolomeo, Dipartimento di Economia e Diritto, Sapienza Università di Roma, via del Castro Laurenziano 9, 00161 Rome, Italy; e-mail: giovanni.dibartolomeo@uniroma1.it.
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Abstract

This paper reconsiders optimal inflation targeting in a model where persistence is generated by rational choices of the price makers because of a time-dependent pricing mechanism. In this framework, which generalizes the traditional Calvo model, inflation persistence is intrinsic, as it is micro-founded assuming that firms' pricing decisions depend on the time elapsed from the last price reset. We use a linear–quadratic approach to study the welfare effects and optimal policies. We disentangled two distortion sources showing how welfare falls in both the average of the probability of changing prices and its distribution among different firms. Described the underlying distortions of our setup, we analyze its normative implications for optimal inflation. The issues of uncertainty and robustness are also considered: By using robust control techniques, we, in fact, consider the consequences of implementing a “wrong” monetary rule due to a misinterpretation of sources of inflation inertia.

Keywords

Time-Dependent Price AdjustmentsIntrinsic Inflation PersistenceOptimal Stabilization PolicyPolicy Robustness
Type
Articles
Information
Macroeconomic Dynamics , Volume 22 , Special Issue 1: Current Macroeconomic Challenges , January 2018 , pp. 135 - 152
Copyright
Copyright © Cambridge University Press 2016 

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Footnotes

The authors are grateful to two anonymous referees, Barbara Annichiarico, Guido Ascari, Efrem Castelnuovo, Bob Chirinko, Giuseppe Ferrero, Peter McAdam, Salvatore Nisticò, Ricardo Reis, Lorenza Rossi, Massimiliano Tancioni, Patrizio Tirelli, and seminar participants at the Universities of Rome (Sapienza CMC conference), Crete, Manchester, Mannheim (ZEW conference), and Tor Vergata for useful comments on earlier drafts. The authors also acknowledge financial support by Sapienza University of Rome.

References

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