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Strategic Complementarities and Optimal Monetary Policy

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Author Info
Andrew T. Levin
J. David Lopez-Salido
Tack Yun

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Abstract

In this paper, we show that strategic complementarities–such as firm-specific factors or quasikinked demand–have crucial implications for the design of monetary policy and for the welfare costs of output and inflation variability. Recent research has mainly used log-linear approximations to analyze the role of these mechanisms in amplifying the real effects of monetary shocks. In contrast, our analysis explicitly considers the nonlinear properties of these mechanisms that are relevant for characterizing the deterministic steady state as well as the second-order approximation of social welfare in the stochastic economy. We demonstrate that firm-specific factors and quasi-kinked demand curves yield markedly different implications for the welfare costs of steady-state inflation and inflation volatility, and we show that these considerations have dramatic consequences in assessing the relative price distortions associated with the Great Inflation of 1965-1979.

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Publisher Info
Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1355.

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Length: 44 pages
Date of creation: Jun 2007
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Handle: RePEc:kie:kieliw:1355

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Related research
Keywords: firm-specific factors quasi-kinked demand welfare analysis

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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