STATE-CONTINGENT INFLATION CONTRACTS AND UNEMPLOYMENT PERSISTENCE

This paper shows that if unemployment (or some other real variable) fo llows a dynamic autoregressive process, the government can still achie ve its precommitment outcome in monetary policy, by offering the centr al banker a linear inflation contract, where the penalty for increment al inflation depends positively on lagged unemployment. This note ther efore offers an extension of recent results of Walsh to the case of pe rsistence in real economic variables such as output or unemployment.