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Gaps and Triangles

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Author Info
Bernardino Adao
Isabel Correia
Pedro Teles

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Abstract

In this paper, we derive principles of optimal cyclical monetary policy in an economy without capital, with a cash-in-advance restriction on household transactions, and monopolistic firms that set prices one period in advance. The only distortionary policy instruments are the nominal interest rate and the money supply. In this environment it is feasible to undo both the cash-in-advance and price setting restrictions, but not the distortion due to monopolistic competition. We show that it is optimal to follow the Friedman rule, and thus offset the cash-in-advance restriction. We also find that, in general, it is not optimal to undo the price setting restriction, so that a simple criterion of eliminating gaps is not optimal. Sticky prices provide the planner with tools to improve upon a distorted flexible price allocation. Copyright The Review of Economic Studies Limited, 2003.

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Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 70 (2003)
Issue (Month): 4 (October)
Pages: 699-713
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Handle: RePEc:bla:restud:v:70:y:2003:i:4:p:699-713

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2002. "Optimal Monetary Policy," NBER Working Papers 9402, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2002. "Optimal fiscal and monetary policy: equivalence results," Working Paper Series WP-02-16, Federal Reserve Bank of Chicago. [Downloadable!]
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  3. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "Price-level and interest-rate targeting in a model with sticky prices," Working Paper 9819, Federal Reserve Bank of Cleveland. [Downloadable!]
  4. Ireland, Peter N, 1996. "The Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 704-23, August. [Downloadable!] (restricted)
  5. Bernardino Adao & Isabel Correia & Pedro Teles, 2000. "The Monetary Transmission Mechanism: Is it Relevant for Policy?," Econometric Society World Congress 2000 Contributed Papers 0967, Econometric Society. [Downloadable!]
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  6. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June. [Downloadable!] (restricted)
  7. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October. [Downloadable!] (restricted)
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  8. Jordi Gali & Tommaso Monacelli, 1999. "Optimal Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Boston College Working Papers in Economics 438, Boston College Department of Economics, revised 15 Nov 1999. [Downloadable!]
  9. Marvin Goodfriend & Robert G. King, 2001. "The Case for Price Stability," NBER Working Papers 8423, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  11. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond. [Downloadable!]
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  12. Charles T. Carlstrom & Timothy S. Fuerst, 1998. "A Note on the Role of Countercyclical Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 106(4), pages 860-889, August. [Downloadable!] (restricted)
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