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It's hard to speak about output gap and inflation without first specifying a particular model and the shock which is assumed to be hitting the economy.

The output gap is the gap between the contemporary output and the output you could achieve at full capacity. I was not aware that this was model-dependent.

To low order, "full capacity" can be approximated by "full employment."

Do you have in mind a classic supply shock here?

No, I'm not talking about a shock. I'm talking about a persistent general glut, due to (a) inefficiencies in private sector capital allocation and (b) the desire to hold an increasing portfolio of sovereign monetary instruments as the economy grows.

Of course, if you're in a neoclassical modelling environment, a persistent general glut is assumed away axiomatically. But I consider that a problem with neoclassical modelling, not with reality.

I agree, but that's not the objective function which calls higher interest rates in Germany.

There is no objective function which does that. See Mig's sig.

From Bundesbank's POV, they have to make sure inflation pressures don't build

But the BuBa should not be making that decision. The ECB should. And from the ECB's PoV, they have to make sure that - since there is no European fiscal transfers budget or Bancor - inflationary pressures do build up in Germany. Because to do otherwise is to imperil the very existence of the Eurozone.

well, Sarkozy could shout all he wants, another Frenchman Trichet isn't going to give in.

Sarko can fire Trichet. Trichet can't fire Sarko.

Plus, we have pretty damn persuasive theories that tell us exactly why 6 or 8% would be bad, as well.

I sure haven't seen any.

Well, I guess we read the NK Macro differently.

I'm pretty sure we don't.

I just don't find a theory of the political economy that implicitly (and occasionally overtly) assumes long-run money neutrality to be particularly convincing.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Jun 18th, 2011 at 05:06:51 PM EST
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