Micro Data on Nominal Rigidity, Inflation Persistence and Optimal Monetary Policy

The popular Calvo model with indexation (Christiano, Eichenbaum and Evans (2005)) and sticky information (Mankiw and Reis (2002)) models 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 two models: the model proposed by Gali and Gertler (1999) and the Generalized Taylor Economy (GTE). These models can explain the persistence of inflation and are 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 illustrate the potential for conclusions from the models that ignore the micro-data to be misleading. ∗I would like to thank Huw Dixon and Raf Wouters for insightful comments that help me to improve the paper. I would also like to thank Luc Aucremanne, Emi Nakamura and participants at presentations at Birmingham, Bristol, the Bank of Canada, the Middle East Technical University, the National Bank of Belgium, the Reserve Bank of New Zealand and the 2010 Royal Economic Society conference for helpful comments. This paper is a revised version of the National Bank of Belgium working paper no: 175. Faults remain my own. †Economics Department, The University of Bristol, Bristol, BS8 1TN. E-mail: [email protected].