Micro data on nominal rigidity, inflation persistence and optimal monetary policy. NBB Working Paper 175, September 2009

Kara, Engin. (2009) Micro data on nominal rigidity, inflation persistence and optimal monetary policy. NBB Working Paper 175, September 2009.

Abstract

The popular Calvo model with indexation (Christiano, Eichenbaum and Evans, 2005) and sticky information (Mankiw and Reis (2002) model have guided much of the monetary policy discussion. The strength of these approaches is that they can explain the persistence of inflation. However, both of these theories are inconsistent with the micro data on prices. In this paper, I evaluate the consequences of implementing policies that are optimal from the perspective of models that overlook the micro-data. To do so, I employ a Generalized Taylor Economy (GTE) (Dixon and Kara, 2007). While there is no material difference between the GTE and its popular alternatives in terms of inflation persistence, a difference arises when it comes to the micro-data: the GTE is consistent with the micro-data. The findings reported in the paper suggest that policy conclusions are significantly affected by whether persistence arises in a manner consistent with the micro-data and that policies that are optimal from the perspective of the models that are inconsistent with the micro-data can lead to large welfare losses in the GTE.