Kiel Working Papers, Kiel Institute for World Economics
No 1358:
Endogenous Indexing and Monetary Policy Models
Richard Mash
Abstract: Models in which firms use rules of thumb or partial
indexing in their price setting have become prominent in the recent
monetary policy literature. The extent to which these firms adjust their
prices to lagged inflation has been taken as fixed. We consider the
implications of firms choosing the optimal degree of indexation so these
simple pricing rules deliver prices as close as possible to those which
would be chosen optimally. We find that the degree of indexation depends on
the extent of persistence in the economy such that models with constant
indexation are vulnerable to the Lucas critique. We also study the
interactions between firms price setting and the macroeconomic environment
finding that, for the models which appear most plausible on microeconomic
grounds, the Nash equilibrium between firms and the policy maker is
characterised by zero indexation and zero macroeconomic persistence.
Keywords: Indexing, Monetary Policy, Phillips curve, Inflation persistence, Microfoundations; (follow links to similar papers)
JEL-Codes: E52,; E58,; E22; (follow links to similar papers)
19 pages, June 2007
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