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Firm-specific capital and welfare

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What are the consequences for monetary policy design implied by the fact that price setting and investment takes typically place simultaneously at the firm level? To address this question we analyze simple (constrained) optimal interest rate rules in the context of a dynamic New Keynesian model featuring firm-speci.c capital accumulation as well as sticky prices and wages à la Calvo. We make the case for Taylor type rules. They are remarkably robust in the sense that their welfare implications do not appear to hinge neither on the speci.c assumptions regarding capital accumulation that are used in their derivation nor on the particular definition of natural output that is used to construct the output gap. On the other hand we find that rules prescribing that the central bank does not react to any measure of real economic activity are not robust in that sense.

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Paper provided by Norges Bank in its series Working Paper with number 2006/04.

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Length: 34 pages
Date of creation: 18 Apr 2006
Date of revision:
Handle: RePEc:bno:worpap:2006_04

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Keywords: Monetary policy; Sticky prices; Aggregate investment;

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  15. Tommy Sveen & Lutz Weinke, 2004. "Pitfalls in the modeling of forward-looking price setting and investment decisions," Economics Working Papers 773, Department of Economics and Business, Universitat Pompeu Fabra.
  16. Tommy Sveen & Lutz Weinke, 2005. "Is lumpy investment really irrelevant for the business cycle?," Working Paper 2005/6, Norges Bank.
  17. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  18. Lutz Weinke & Tommy Sveen, 2003. "Inflation and output dynamics with firm-owned capital," Economics Working Papers 702, Department of Economics and Business, Universitat Pompeu Fabra.
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  22. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
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