The Costs of Inflation in New Keynesian Models

Ambler describes three new channels through which inflation affects economic welfare in New Keynesian models. These channels were absent from traditional analyses and may have caused researchers to underestimate the costs associated with variable inflation, even at relatively low levels of inflation. The article concludes with a preliminary assessment of the quantitative importance of the new channels and their significance for monetary policy.

Nominal Wage Rigidity as a Nash Equilibrium

Models of the microfoundations of nominal price rigidities show that in the absence of real rigidities, individual firms have strong incentives to adjust prices even if other firms do not: price rigidity is not a Nash equilibrium unless the fixed cost of adjusting prices is implausibly high. This paper shows that nominal wage rigidity can be supported as a Nash equilibrium with relatively small adjustment costs and without real rigidities. The size of the necessary adjustment costs decreases labor supply elasticity increases, but is quite small for empirically plausible values of the latter. The minimum adjustment cost is relatively insensitive to the degree of substitutability between types of labor in production.Nominal Wage Rigidity, Nash Equilibrium

Price-Level Targeting and Stabilization Policy: A Review

This article reviews arguments in the literature for and against price-level targeting, focusing on its costs and benefits compared with inflation targeting. Benefits of price-level targeting include the effect on forward-looking inflation expectations; the ability to substitute for commitment by a central bank to its future policies; lessening forecast errors; better economic performance in response to real shocks because of lower wage indexation; and a reduction in the problem of the zero lower bound on nominal interest rates. Strict price-level targeting is not appropriate when inflation expectations are not fully forward-looking, and targeting the overall price level may be harmful if there are volatile movements in some of its components.

Time-Consistent Control in Non-Linear Models

We show how to use optimal control theory to derive optimal time-consistent Markov-perfect government policies in nonlinear dynamic general equilibrium models, extending the result of Cohen and Michel (1988) for models with quadratic objective functions and linear dynamics. We replace private agents' costates by flexible functions of current states in the government's maximization problem. The functions are verified in equilibrium to an arbitrarily close degree of approximation. They can be found numerically by perturbation or projection methods. We use a stochastic model of optimal public spending to illustrate the technique.Fiscal policy; Monetary policy framework

La stationnarité en économétrie et en macroéconomique : un guide pour les non initiés

Le but de ce texte est de présenter une introduction non technique à l’utilisation et à l’importance de séries chronologiques non stationnaires en économétrie et en macroéconomique. Les sujets suivants font l’objet de la présentation : la distinction entre tendances stochastiques et tendances déterministes; les tests d’hypothèse pour discriminer entre séries non stationnaires avec tendances stochastiques, d’une part, et, d’autre part, séries qui sont stationnaires autour de tendances déterministes; les conséquences de la non-stationnarité pour la théorie macroéconomique; les tests de stationnarité en présence de changements structurels; l’estimation de modèles économétriques avec variables qui sont individuellement non stationnaires.The paper gives a non-technical introduction to non-stationary time series and considers their importance in macro-econometrics and macroeconomics. The following topics are discussed: the distinction between stochastic and deterministic trends; statistical tests for discriminating between non-stationary series with stochastic trends and series which are stationary or which are stationnary around a deterministic time trend; the importance of unit roots for macroeconomic theory; structural breaks and tests for stochastic trends; the estimation of time series models with non-stationary variables; the existence of stable relationships among variables which are individually non-stationary

Les modèles du cycle économique face à la corrélation productivité-emploi

Depuis l’époque de Keynes, Dunlop et Tarshis, les questions de la nature procyclique du salaire réel, de la corrélation entre la productivité des travailleurs et l’emploi, et de la compatibilité de ces faits observés avec les théories du cycle économique suscitent de vives controverses. Dans ce texte, nous évaluons les théories modernes du cycle économique en rapport avec ces faits observés importants, avec une emphase particulière sur les modèles du cycle à caractère réel (MCR). Notre verdict est que les MCR n’engendrent pas de comouvements qui sont conformes aux faits; les tentatives récentes de modifier les MCR pour corriger leurs défauts au plan empirique ne respectent pas entièrement l’esprit original de l’approche MCR.Since the time of Keynes, Dunlop and Tarshis, questions concerning the procyclicity of real wages, the correlation between labor productivity and employment, and the compatibility of these stylized facts with business cycle theories have been highly controversial. In this paper, we evaluate modern business cycle theories in the light of these stylized facts, with a particular emphasis on real business cycle (RBC) models. Our judgment is that RBC models do not generate comovements like those observed in the data. Recent attempts to modify RBC models to correct their empirical shortcomings have not entirely respected the basic philosophy of the RBC approach

Optimal Taylor Rules in an Estimated Model of a Small Open Economy

We develop a model of a small open economy with three types of nominal rigidities (domestic goods prices, imported goods prices and wages) and eight different structural shocks. We estimate the model's structural parameters using a maximum likelihood procedure and use it to compute welfare-maximizing Taylor rules for setting domestic short-term interest rates. For these computations, we use a second-order approximation around the model's deterministic steady state, which allows the Taylor rule coefficients to affect the means of consumption, leisure and real balances as well as their variances. Welfare gains from moving to the optimal Taylor rule are substantial, but require a very precise knowledge of the values of the model's structural parameters.Economic models; Open economy; Optimal monetary policy; Taylor rules

Optimal Taylor Rules in an Estimated Model of a Small Open Economy

The authors compute welfare-maximizing Taylor rules in a dynamic general-equilibrium model of a small open economy. The model includes three types of nominal rigidities (domestic-goods prices, imported-goods prices, and wages) and eight different structural shocks. The authors estimate the model's structural parameters by maximum likelihood using Canadian and U.S. data, and use a second-order approximation of the model to measure the welfare effects of different Taylor rules. By estimating the model, the authors can compare welfare levels with that attainable under the Taylor rule estimated for their sample period. They find that the welfare gains from moving to the optimal Taylor rule are larger than those obtained by previous researchers.Economic models; Exchange rates; Inflation targets

The Macroeconomic Effects of Non-Zero Trend Inflation

The authors study the macroeconomic effects of non-zero trend inflation in a simple dynamic stochastic general-equilibrium model with sticky prices. They show that trend inflation leads to a substantial reduction in the stochastic means of output, consumption, and employment. It also leads to an increase in the variability and persistence of most aggregates. Price dispersion across firms unambiguously increases the welfare costs of inflation. The effects hold qualitatively no matter how sticky prices are modelled, but they are quantitatively much stronger under Calvo pricing.Business fluctuations and cycles; Economic models; Inflation and prices; Inflation targets

Nominal Rigidities and Exchange Rate Pass-Through in a Structural Model of a Small Open Economy

The authors analyze exchange rate pass-through in an estimated structural model of a small open economy that incorporates three types of nominal rigidity (wages and the prices of domestically produced and imported goods) and eight different structural shocks. The model is estimated using quarterly data from Canada and the United States. It predicts a remarkably similar dynamic relationship between the nominal exchange rate and prices in response to the different structural shocks: the nominal exchange rate overshoots its long-run level, and changes in the nominal exchange rate are passed through slowly to the domestic price level. The authors show that, although pricing to market (the slow adjustment of the domestic-currency prices of imported goods) is necessary to generate slow pass-through to the prices of imported goods, it is not necessary to generate slow pass-through to the overall price level. Sticky domestic wages also generate slow exchange rate pass-through, even when the prices of imported goods adjust instantaneously to changes in the exchange rate.Business fluctuations and cycles; Economic models; Exchange rates; Inflation and prices; International topics