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Abstract

Much of the literature on optimal monetary policy uses models in which the degree of nominal price flexibility is exogenous. There are, however, good reasons to suppose that the degree of price flexibility adjusts endogenously to changes in monetary conditions. This paper extends the standard New Keynesian model to incorporate an endogenous degree of price flexibility. The model shows that endo?genising the degree of price flexibility tends to shift optimal monetary policy towards complete inflation stabilisation, even when shocks take the form of cost-push distur?bances. This contrasts with the standard result obtained in models with exogenous price flexibility, which show that optimal monetary policy should allow some degree of inflation volatility in order to stabilise the welfare-relevant output gap.

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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 1007.

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Date of creation: Feb 2010
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Handle: RePEc:san:cdmawp:1007

Contact details of provider:
Postal: School of Economics and Finance, University of St. Andrews, Fife KY16 9AL
Phone: 01334 462420
Fax: 01334 462444
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Web page: http://www.st-andrews.ac.uk/cdma
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Related research

Keywords: Welfare; Endogenous Price Flexibility; Optimal Monetary Policy.;

Other versions of this item:

Find related papers by JEL classification:

• E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
• E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

This paper has been announced in the following NEP Reports:

• NEP-ALL-2010-03-20 (All new papers)
• NEP-CBA-2010-03-20 (Central Banking)
• NEP-MAC-2010-03-20 (Macroeconomics)
• NEP-MON-2010-03-20 (Monetary Economics)

References

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   • Henry Siu & Michael B. Devereux, 2004. "State Dependent Pricing and Business Cycle Asymmetries," 2004 Meeting Papers 161, Society for Economic Dynamics.
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