Backward-looking indexation, credibility and inflation persistence

Inflation persistence is a stylized fact after disinflation. Standard staggered-prices models show very Little or no inflation persistence and, hence, are of little use when inflation is sticky. In this paper, I present a model that, on the one hand, is consistent with the evidence of sticky inflation and, on the other, can be directly incorporated into modem intertemporal optimizing models. The model modifies Calvo's [Calvo, G., 1983a. Staggered contracts and exchange rate policy. In: J.A. Frenkel (Ed.), Exchange Rates and International Economics, University of Chicage Press, Chicago, IL; Calvo, G., 1983b. Staggered wages in a utility maximization framework, Journal of Monetary Ecomomics 12(3), 383-393] exclusively forward-looking model and includes a backward-looking component. It encompasses the two extreme cases of purely forward and backward-looking price setting. I show how the model can be used in open economy stabilization programs. This is not the first model including a form of backward indexation in a staggered-prices setting. However, it has the advantage of keeping the analytical elegance of the Calvo model while enhancing its dynamics. (C) 2001 Elsevier Science B.V. All rights reserved.