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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Using a projection method to analyze inflation bias in a micro-founded model
Gary S. Anderson
Jinill Kim
Tack Yun
Abstract

Since Kydland and Prescott (1977) and Barro and Gordon (1983), most studies of the problem of the inflation bias associated with discretionary monetary policy have assumed a quadratic loss function. We depart from the conventional linear-quadratic approach to the problem in favor of a projection method approach. We investigate the size of the inflation bias that arises in a microfounded nonlinear environment with Calvo price setting. The inflation bias is found to lie between 1% and 6% for a reasonable range of parameter values, when the bias is defined as the steady-state deviation of the discretionary inflation rate from the optimal inflation rate under commitment.


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Gary S. Anderson & Jinill Kim & Tack Yun, Using a projection method to analyze inflation bias in a micro-founded model, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2010-18, 2010.
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Keywords: Inflation (Finance) ; Econometric models
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