DP5534 | Inflation Bias with Dynamic Phillips Curves

Publication Date

02/03/2006

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Abstract

We generalise the analysis of inflation bias with dynamic Phillips curves in three respects. First, we examine the discretionary (time consistent) solution in cases where the Phillips curve has both a backward looking and forward-looking component. Second, we show that the commitment (time inconsistent) solution does not normally involve zero inflation and output at its natural rate. Instead, with a purely forward-looking Phillips curve and positive discounting, it will involve a dynamic path for inflation in which steady state inflation is below its target. In this sense, we obtain negative inflation bias. Third, we show that the timeless perspective policy has the same steady state as the commitment case, but without any short-term output gains.