Backward-Looking Contracts, Credibility and Inflation Convergence

In this paper, we build a model that incorporates a backward-looking component to the exclusively forward-looking staggered prices model of Calvo (1983). The objective of this formulation is to include the effect of the history of high inflation on the price formation, reflected in the existence of widespread backward-looking indexation (-de facto or de jure-). Thus, the model is able to isolate the effects of history in price setting from the genuinely forward-looking lack of credibility arising from the intertemporal inconsistency between fiscal and monetary policy. One remarkable feature of the model is that it remains analytically tractable despite its enhanced dynamics. When used to simulate, the model replicates inflation persistence and real appreciation. Immediate inflation convergence is not achievable even if the economy's fundamentals would say so.

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Working or Discussion Paper
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JEL Codes:
E31; E52
Series Statement:
Working Paper

 Record created 2017-04-01, last modified 2020-10-28

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