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Optimal monetary policy with state-dependent pricing

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  • Anton Nakov

    ()
    (Banco de España and ECB)

  • Carlos Thomas

    ()
    (Banco de España)

Abstract

We study optimal monetary policy from the timeless perspective in a general state-dependent pricing framework. Firms are monopolistic competitors and are subject to idiosyncratic menu cost shocks. We find that, under isoelastic preferences and no government spending, strict price stability is optimal both in the long run and in response to aggregate shocks. Key to this finding is an “envelope” property: at zero inflation, a marginal increase in the rate of inflation has no effect on firms’ profits and therefore has no effect on the rate of price adjustment. We offer an analytic solution which does not rely on local approximation or efficiency of the steady-state.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/11/Fich/dt1130e.pdf
File Function: First version, November 2011
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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1130.

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Length: 36 pages
Date of creation: Nov 2011
Date of revision:
Handle: RePEc:bde:wpaper:1130

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Keywords: monetary policy; state-dependent pricing; monopolistic competition;

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  1. Denny Lie, 2009. "State-dependent pricing and optimal monetary policy," Working Papers, Federal Reserve Bank of Boston 09-20, Federal Reserve Bank of Boston.
  2. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 89-109, March.
  3. Mikhail Golosov & Robert E. Lucas Jr., 2007. "Menu Costs and Phillips Curves," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 115, pages 171-199.
  4. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  5. Oleksiy Kryvtsov & Peter J. Klenow, 2004. "State-Dependent or Time-Dependent Pricing: Does It Matter For Recent U.S. Inflation?," Computing in Economics and Finance 2004, Society for Computational Economics 277, Society for Computational Economics.
  6. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation stabilization and welfare: The case of a distorted steady state," Discussion Papers, Columbia University, Department of Economics 0405-04, Columbia University, Department of Economics.
  7. James Costain & Anton Nakov, 2011. "Price Adjustments in a General Model of State‐Dependent Pricing," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 43, pages 385-406, 03.
  8. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 114(2), pages 655-690, May.
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