MONETARY POLICY WITH AN ENDOGENOUS CAPITAL STOCKWHEN INFLATION IS PERSISTENT

The paper presents a monetary policy model with an endogenous capital stock when a backwardlooking element in wage setting causes inflation persistence. We analyse how the endogeneityof the capital stock changes the macroeconomic dynamics with which policy interacts and itsimplications for optimal policy and time inconsistency. Capital stock endogeneity makesinflation more persistent in reduced form. This makes the optimal contemporaneous policyresponse to shocks more vigorous but the subsequent return to steady state more gradual.Observed output becomes more serially correlated. Capital endogeneity can also give rise todisinflation bias under discretion for some parameter values....