A Cold-Turkey versus a Gradualist Approach in a Menu Cost Model

Disinflations typically lead to recessions in actual economies. A classical policy issue is the choice between a cold-turkey and a gradualist approach to minimize the output loss associated with a period of disinflation. This paper explores which policy option is less costly in terms of foregone output through a menu cost model in which the credibility of government policies is the decisive factor in determining the appropriate speed of disinflation. It shows that, in the event of non-credibility, cold-turkey disinflation minimizes foregone output, whereas full credibility favors a gradualist approach.