Inflation targets, endogenous mark-ups and the non-vertical Phillips curve.

Transcription

1 Riccardo Faini Ceis Seminar Tor Vergata Ceis November 20, 2009 Inflation targets, endogenous mark-ups and the non-vertical Phillips curve. Giovanni Di Bartolomeo University of Teramo Patrizio Tirelli University of Milan Bicocca Nicola Acocella University of Rome La Sapienza Faculty of Communication

2 Aim of the paper Over the last decade central banks have shifted to a policy of announcing non-zero inflation targets. The theoretical justification for this policy is however hardly found in micro-founded models (as acknowledged in Schmitt-Grohé and Uribe, S-G&U, 2007). Moreover, positive trend inflation characterizes all economic systems. Our paper faces this problem. Inflation as a tax on money balances + wage negotiations take place while expiring contracts are still in place

3 Related literature S-G&U (2004a). Kiley (2007). Ropele and Ascari (2007). Khan et al. (2003). S-G&U (2007). Benigno, Ricci (2008). Graham, Snower (2008) Assume exogenous (calibrated) trend inflation and often derive optimal policies. Inflation has long-run adverse effects due to relative price dispersion and to the effect of expectations on mark-ups. Trade off between Friedman rule (deflation is optimal) and resource misallocation from staggered prices (zero inflation is optimal) to find negative trend inflation. Positive long-run effect: a) grease in the wheels argument: ex. downward nominal rigidities implies non-vertical Phillips curve. b) Staggered nominal contracts with hyperbolic discounting

4 Back to Schmitt-Grohé Related and literature Uribe (2007), the theoretical justification for positive inflation is hardly found in microfounded models. S-G&U (2004a). Kiley (2007). Inflation and long-run inflation Inflation targeting has long-run adverse effects due to relative price dispersion and to the effect of expectations on mark-ups. Ropele and Ascari (2007). Khan et al. (2003). S-G&U (2007). Benigno, Ricci (2008). Graham, Snower (2008) Assume exogenous (calibrated) trend inflation and often derive optimal policies. Trade off between Friedman rule (deflation is optimal) and resource misallocation from staggered prices (zero inflation is optimal) to find negative trend inflation. Positive long-run effect: a) grease in the wheels argument: ex. downward nominal rigidities implies non-vertical Phillips curve. b) Staggered nominal contracts with hyperbolic discounting Ireland (2007) and Cogley and Sbordone (2008)

5 The building blocks Some recent papers (e.g. search-theoretic models of monetary exchange) resurrect the view that welfare costs of inflation arise because the latter acts as a tax on money balances. Recent empirical works on institutional features of the labor market show that wage negotiations take place while expiring contracts are still in place. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we find a disciplining effect of a positive inflation target on the wage markup and identify a long-term trade-off between inflation and output.

6 A simple GE model Consumers: standard neo-classical consumers with money cash-in-advance constraint. Good demand, Euler equation, Money demand Good market: monopolistic competition with flexible prices. Labor demand Labor market: monopolistic (atomistic) wage setters with preset wage with respect to monetary policy. Labor supply Monetary policy: central bank maximizes welfare. Commitment to a policy rule (inflation target)

7 Timing and 3 key-assumptions At the beginning of the period, the central bank commits to an interest rate rule that assures the achievement of a certain exogenous inflation target. Given the central bank rule, (atomistic) wage setters choose the nominal wage rate forming rational expectations: wages are preset with respect to price and monetary policy. Given the wages, the interest rate is actually set by central bank according to its target. Consumers chooses consumption and money balance for the next period (staggered mechanism in money acquisition) and full price flexibility ensures that markets clear.

8 The formal model in summary

9 The formal model in summary

10 The formal model in summary

11 The formal model in summary

12 Equilibrium By solving (equating demand and supply of labor), we can show that moderation in wage claims induced by the inflation target implies higher employment in equilibrium, i.e. a non-vertical long-run Phillips curve.

13 Non Vertical Phillips curve

14 Intuition of the result By a commitment to a non-zero inflation target, ceteries paribus, the central bank changes the expected marginal benefit of holding money. But people cannot adjust nominal holding. Wage setters however anticipate the effects of targeting on equilibrium money balances: M t gb C 1/e t 1+ target - b === P t This induces wage setters to stimulate consumption and to support employment through moderate wage claims. In other words, a positive inflation target raises the wage setters cost from raising the real wage.

15 The moderation effect C cost less M/P has a big impact on welfare

16 2% Markup shock

17 Markup shock 6% 1% markup shock 2%

18 Welfare analysis!!! A B Target C

19 Welfare analysis!!! A B Problem: infinite money demand when the Friedman rule is implemented C

20 Transaction cost Intuition & preliminary results In the spirit of Schmitt-Grohé and Uribe (2007) Preferences The budget constraint u(l,c) C(1+S) + = W/P + S=s(C, v 0 ) is the unit transaction cost. It inversely depends on the money velocity (v=py/m) and consumption level (possible scale effects) Friedman rule: There is a satiation level, v 0, for which s(v 0 )=0. It implies p = b -1. Inflation is a cost (ceteris paribus increases the velocity), thus our moderation mechanism works. Our preliminary results (not reported) are encouraging. Under realistic parameterization, we obtain that inflation targeting dominates the Friedman rule.

21 Conclusions We obtain a non-vertical long-run Phillips curve. The key assumption for our result is that nominal wages are predetermined to both the individual households' and the policymaker's decisions and the staggered mechanism of money acquisition. Next steps are to modify the transaction cost to obtain a non infinite money demand when the Friedman rule is implemented. or explicitly introduce money demand using search models. include staggered prices, which may imply a further incentive to deviate from the Friedman rule, but a disincentive for positive targets