Inflation Targets, Credibility, and Persistence in a Simple Sticky-Price Framework

This paper presents a re-formulated version of a canonical sticky-price model that has been extended to account for variations over time in the central bank’s inflation target. We derive a closed-form solution for the model, and analyze its properties under various parameter values. The model is used to explore topics relating to the effects of disinflationary monetary policies and inflation persistence. In particular, we employ the model to illustrate and assess the critique that standard sticky-price models generate counter factual predictions for the effects of monetary policy.

Introduction
An important trend in macroeconomic research in recent years involves the increased use of optimization-based sticky-price models to analyze how monetary policy affects the economy and how optimal policy should be designed. Much of this analysis employs a simple baseline model that features a “new-Keynesian” Phillips curve to characterize inflation, an “expectational IS curve” to determine output growth, and a policy rule that describes how the central bank sets short-term interest rates; representative examples of studies that use this framework include Clarida, Gali, and Gertler (1999), McCallum (2001), and Wood-ford (2003).

Author: Jeremy Rudd and Karl Whelan

Source: Lancaster University Management School

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