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Relative Price Distortions and Inflation Persistence

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Author Info
Tatiana Damjanovic ()
Charles Nolan ()

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Abstract

Many sticky-price models suggest that relative price distortion is one of the major costs of inflation. We show that this resource misallocation is costly even at quite low rates of inflation. This is because inflation strongly affects price dispersion which in turn has an impact on the economy qualitatively similar to, and of the order of magnitude of, a negative shift in productivity. Similarly, the utility cost of price dispersion is large. We incorporate price dispersion in a linearized model. This radically affects how shocks are transmitted through the economy. Notably, a contractionary nominal shock has a persistent, negative hump-shaped impact on inflation, but may have a positive hump-shaped impact on output. Observed persistence in the policy rate is not due to the policy rule per se.

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Publisher Info
Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 0611.

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Date of creation: Nov 2006
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Handle: RePEc:san:cdmawp:0611

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Related research
Keywords: Price stickiness; optimal fiscal and monetary policies; price dispersion.;

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization

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References listed on IDEAS
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. Michael R. Baye & John Morgan & Patrick Scholten, 2004. "Price Dispersion In The Small And In The Large: Evidence From An Internet Price Comparison Site," Journal of Industrial Economics, Blackwell Publishing, vol. 52(4), pages 463-496, December. [Downloadable!] (restricted)
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  2. Hahn, F H, 1971. "Equilibrium with Transaction Costs," Econometrica, Econometric Society, vol. 39(3), pages 417-39, May. [Downloadable!] (restricted)
  3. Olivier J. Blanchard & Jordi Galí, 2005. "Real wage rigidities and the New Keynesian model," Proceedings, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
    Other versions:
  4. Nicolae, Anamaria & Nolan, Charles, 2006. "The Impact of Imperfect Credibility in a Transition to Price Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 47-66, February. [Downloadable!] (restricted)
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  5. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September. [Downloadable!] (restricted)
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  6. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2005. "Price- and wage- inflation targeting: variations on a theme by Erceg, Henderson, and Levin," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 181-215. [Downloadable!]
  7. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May. [Downloadable!] (restricted)
  8. Richard Mash, 2004. "Optimising Microfoundations for Inflation Persistence," Economics Series Working Papers 183, University of Oxford, Department of Economics. [Downloadable!]
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  9. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December. [Downloadable!] (restricted)
  10. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March. [Downloadable!]
  11. Gatti, J.R.J. & Kattuman, P., 2003. "Online Price Dispersion Within and Between Seven European Countries," Cambridge Working Papers in Economics 0343, Faculty of Economics, University of Cambridge. [Downloadable!]
  12. 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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  13. Peter N. Ireland, 1996. "Stopping inflations, big and small," Working Paper 96-01, Federal Reserve Bank of Richmond. [Downloadable!]
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Cited by:
(explanations, 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. Tatiana Damjanovic & Charles Nolan, 2008. " Seigniorage-maximizing inflation," CDMA Working Paper Series 0807, Centre for Dynamic Macroeconomic Analysis. [Downloadable!]
  2. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2007. " Unconditionally Optimal Monetary Policy," CDMA Working Paper Series 0721, Centre for Dynamic Macroeconomic Analysis. [Downloadable!]
    Other versions:
  3. Tatiana Damjanovic & Charles Nolan, 2009. " Second Order Accurate Approximation to the Rotemberg Model Around a Distorted Steady State," CDMA Working Paper Series 0907, Centre for Dynamic Macroeconomic Analysis. [Downloadable!]
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