DP5616 Calvo Contracts - Optimal Indexation in General Equilibrium
|Author(s):||Vo Phuong Mai Le, Patrick Minford|
|Publication Date:||April 2006|
|Keyword(s):||Calvo contracts, indexing, New Keynesian|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=5616|
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.