Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/25552
Authors: 
Wieland, Volker
Year of Publication: 
2008
Series/Report no.: 
CFS Working Paper 2008/17
Abstract: 
This paper introduces adaptive learning and endogenous indexation in the New-Keynesian Phillips curve and studies disinflation under inflation targeting policies. The analysis is motivated by the disinflation performance of many inflation-targeting countries, in particular the gradual Chilean disinflation with temporary annual targets. At the start of the disinflation episode price-setting firms' expect inflation to be highly persistent and opt for backward-looking indexation. As the central bank acts to bring inflation under control, price-setting firms revise their estimates of the degree of persistence. Such adaptive learning lowers the cost of disinflation. This reduction can be exploited by a gradual approach to disinflation. Firms that choose the rate for indexation also re-assess the likelihood that announced inflation targets determine steady-state inflation and adjust indexation of contracts accordingly. A strategy of announcing and pursuing short-term targets for inflation is found to influence the likelihood that firms switch from backward-looking indexation to the central bank's targets. As firms abandon backward-looking indexation the costs of disinflation decline further. We show that an inflation targeting strategy that employs temporary targets can benefit from lower disinflation costs due to the reduction in backward-looking indexation.
Subjects: 
Learning
Monetary Policy
New-Keynesian Model
Indexation
Inflation Targeting
Disinflation
Recursive Least Squares
JEL: 
E32
E41
E43
E52
E58
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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