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Title: Calvo Contracts - Optimal Indexation in General Equilibrium

Author(s): Vo Phuong Mai Le and Patrick Minford

Publication Date: April 2006

Keyword(s): Calvo contracts, indexing and New Keynesian

Programme Area(s): International Macroeconomics

Abstract: Calvo contracts, which are the basis of the current generation of New Keynesian models, widely include indexation to general inflation. We argue that the indexing formula should be expected inflation rather than lagged inflation. This optimises the welfare of the representative agent in a general equilibrium model of the New Keynesian type. This is shown analytically for a simplified model and by numerical simulation for a full model with price and wage contracts as well as capital. The consequence of such indexation is that monetary policy no longer has any effect on welfare.

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Bibliographic Reference

Le, V and Minford, P. 2006. 'Calvo Contracts - Optimal Indexation in General Equilibrium'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=5616