Inflation inertia and optimal disinflation

Abstract

The Reserve Bank Act of 1989 can be viewed as a means of providing credibility to the Reserve Bank's attempts to lower inflation and as a solution to the inflationary bias inherent in the discretionary conduct of monetary policy. Many of the critics of the Reserve Bank's policies have argued that inflation in New Zealand is inertial in nature, that wages and expectations adjust only slowly, and that, as a consequence, the output (or unemployment) costs of disinflation are unacceptably high. The purpose of this paper is to examine how the optimal commitment to a disinflationary policy is affected by the degree of inertia in the inflation process.

Notes

The first draft of this paper was written while I was a Fulbright Fellow at the New Zealand Institute of Economic Research. Any opinions expressed are not necessarily those of the Federal Reserve Bank of San Francisco, the Federal Reserve System or the New Zealand Institute of Economic Research. I would like to thank the referees‐for useful suggestions and comments that substantially improved the ‘paper. Remaining errors are my own.