New Keynesian microfundations revisited: a generalised Calvo-Taylor model and the desirability of inflation vs. price level targeting

Working paper

Optimal monetary policy is sensitive to the Phillips curve specification used to represent the dynamics of inflation and output. Most recent literature has used a new Keynesian Phillips Curve based on Calvo pricing. This paper shows that this workhorse model is not robust to relatively minor changes in its microfoundations, in particular allowing for time varying probabilities of a firm being able to reset its price. We derive a general model that nests Calvo and the Taylor staggering model as special cases and analyse its implications for optimal policy, including the relative desirability of inflation and price level targeting.

Authors: Mash, R

• Publication status: Published
• Publisher: University of Oxford
• Series: Department of Economics Discussion Paper Series
• Publication date: 2002-07-01
• Paper number: 109
• Keywords: inflation targeting; forwarding looking expectations; stabilisation bias; New Keynesian Phillips curve; price level targeting