Abstract
We develop a New Keynesian model featuring Calvo price setting and Calvo wage setting to quantify the welfare consequences of shifting trend inflation in Vietnam. To capture the characteristics of the Vietnamese economy, we use the Simulated Method of Moment and calibrate parameters jointly to match the important selected moments of Vietnamese data. The results show a severe consequence of a constant positive trend inflation and an exogenous shock to trend inflation, especially when a central bank sets a high level of inflation target. Among staggered price and wage contracts, the latter play a vital role in transmitting the adverse impacts of constant and shifting trend inflation into the economy. Based on our analyses, raising inflation targets would seem to be a bad policy prescription in Vietnam.
Highlights
Vietnam has experienced periods of unstable inflation in the past
The results suggest that the sudden change in inflation targets might cause severe welfare consequences in developing countries like Vietnam
This paper made its key contribution by exploiting the welfare consequences of shifting trend inflation, a salient property of developing countries like Vietnam, by building a New Keynesian model featuring a Calvo price setting
Summary
Vietnam has experienced periods of unstable inflation in the past. In recent years, bad signals in the world market, such as an upsurge in the prices of commodity and petroleum, have raised concerns regarding potential substantial rises in future inflation in Vietnam. To model the substantial rise in inflation, many authors, such as Kozicki and Tinsley (2001), Ireland (2007), Cogley, Primiceri, and Sargent (2009) and Nakata (2014) have employed a highly persistent trend inflation process to depict slow changes in implicit inflation targets set by a central bank. Closely related to dynamic behavior of consumption and labor supply, are important for welfare cost computations, which are the main exercise of the paper With these considerations, we show that the consequences of constant and shifting trend inflation are severe, especially when a central bank sets a high inflation target level. Our conclusion in the case of developing country is aligned with Ascari et al (2018), who conducted a similar exercise in the U.S In the present study, we provide additional evidence for the role of staggered wage contracts in the welfare consequences of shifting trend inflation.
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