DP3038 No Pain, No Gain? The Simple Analytics of Efficient Disinflation in Open Economies
|Author(s):||Willem H. Buiter, Clemens Grafe|
|Publication Date:||November 2001|
|Keyword(s):||disinflation, new Keynesian Phillips curve, sacrifice ratio|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=3038|
The Paper studies the design of efficient disinflation programmes in open economies using the sacrifice ratio; that is, the cumulative additional un-employment or cumulative lost output required to achieve a 1% sustained reduction in the rate of inflation, as the metric of efficiency. The ?new Keynesian? Phillips curve first proposed by Calvo has a zero sacrifice ratio: costless disinflation is possible, because the inflation process is purely forward-looking. There is inertia or rigidity in the price level but not in the rate of inflation. More interesting inflation kernels for which current inflation is partly forward-looking and partly backward-looking have a positive sacrifice ratio. Real exchange rate appreciation early in the disinflation process may raise the sacrifice ratio relative to a policy that keeps the real exchange rate constant. The sacrifice ratio is lower under gradualism than under ?cold turkey?. Effficient disinflation policies may, however, be time-inconsistent and therefore not credible.