Department of Economics
University of Delaware
Working Paper #2006-13
State-Dependent Nominal Rigidities & Disinflation Programs in Small Open Economies
Experiences of high-inflation economies suggest that exchange rate-based (ERB) and money-based (MB) disinflations induce sharply different dynamics in consumption and GDP. I study the role of nominal rigidities to explain such dynamics. I build on Calvo pricing to introduce elements of state-dependent into an otherwise standard small open economy. This new feature delivers state-dependent nominal rigidities (SDNR). Nonlinear simulations show that the model with SDNR generates a dynamic behavior consistent with both ERB and MB disinflations; however the model’s special case with constant nominal rigidities is not successful rationalizing ERB disinflations.
JEL CODES: E31, E32, E37
KEY WORDS: Nominal rigidities, disinflations, state-dependent pricing, exchange-rate based stablizations