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Time consistent monetary policy with endogenous price rigidity

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  • Siu, Henry E.

Abstract

In this paper I characterize time consistent equilibrium in an economy with price rigidity and an optimizing monetary authority operating under discretion. Firms have the option to increase their frequency of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant degree of price rigidity across inflation regimes, find two time consistent equilibria - one with low inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of price rigidity.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 138 (2008)
Issue (Month): 1 (January)
Pages: 184-210

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Handle: RePEc:eee:jetheo:v:138:y:2008:i:1:p:184-210

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Web page: http://www.elsevier.com/locate/inca/622869

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Cited by:
  1. Marco Bonomo & Carlos Carvalho, 2008. "Imperfectly credible disinflation under endogenous time-dependent pricing," Staff Reports 355, Federal Reserve Bank of New York.
  2. David M. Arseneau, 2004. "Expectation traps in a New Keynesian open economy model," Finance and Economics Discussion Series 2004-45, Board of Governors of the Federal Reserve System (U.S.).
  3. Gomes, O. & Mendes, D. A. & Mendes, V. P. & Sousa Ramos, J., 2007. "Endogenous Cycles in Optimal Monetary Policy with a Nonlinear Phillips Curve," Money Macro and Finance (MMF) Research Group Conference 2006 139, Money Macro and Finance Research Group.
  4. Armenter, Roc, 2013. "The perils of nominal targets," Working Papers 14-2, Federal Reserve Bank of Philadelphia.
  5. Schabert, Andreas, 2005. "Discretionary Policy, Multiple Equilibria, and Monetary Instruments," CEPR Discussion Papers 5400, C.E.P.R. Discussion Papers.
  6. Andreas Schabert, 2005. "Discretionary Policy, Multiple Equilibria, and Monetary Instruments," Tinbergen Institute Discussion Papers 05-098/2, Tinbergen Institute.
  7. Eric Swanson & Gauti Eggertsson, 2007. "Optimal Time-Consistent Monetary Policy in the New Keynesian Model with Repeated Simultaneous Play," 2007 Meeting Papers 214, Society for Economic Dynamics.

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