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Inflation Persistence, Price Indexation and Optimal Simple Interest Rate Rules
Author(s) -
Ascari Guido,
Branzoli Nicola
Publication year - 2015
Publication title -
the manchester school
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.361
H-Index - 42
eISSN - 1467-9957
pISSN - 1463-6786
DOI - 10.1111/manc.12117
Subject(s) - indexation , economics , inflation (cosmology) , real interest rate , output gap , monetary policy , economic stability , relative price , persistence (discontinuity) , monetary economics , econometrics , price of stability , keynesian economics , macroeconomics , physics , geotechnical engineering , theoretical physics , engineering
We study the properties of the optimal interest rate rule under different sources of inflation persistence. In our model, the optimal policy minimizes price dispersion, which depends on the degree of price indexation. When indexation is zero, inflation persistence depends only on the level of trend inflation, the inflation gap is purely forward‐looking and the optimal policy targets inflation stability. Full indexation makes the inflation gap persistent, eliminates the effects of trend inflation and makes the optimal policy target the real interest rate. We compare our results with empirical estimates of the FED's policy in the post‐ WWII era.