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Relative Price Distortions and Inflation Persistence

  • Tatiana Damjanovic
  • Charles Nolan

Sticky-price models often suggest that relative price distortion is a major cost of inflation. We provide an intuition for this: Even at low rates, 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. The utility cost of price dispersion is quantified and its impact on optimal monetary policy discussed. Price dispersion is incorporated into a linearised model. Strikingly, a contractionary nominal shock has a persistent, negative hump-shaped impact on inflation but may have a positive hump-shaped impact on output. Copyright � The Author(s). Journal compilation � Royal Economic Society 2009.

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Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 120 (2010)
Issue (Month): 547 (09)
Pages: 1080-1099

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Handle: RePEc:ecj:econjl:v:120:y:2010:i:547:p:1080-1099
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  1. Richard Mash, 2006. "Optimising Microfoundations for Inflation Persistence," Computing in Economics and Finance 2006 457, Society for Computational Economics.
  2. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
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  12. Anamaria Nicolae & Charles Nolan, 2004. "The Impact of Imperfect Credibility in a Transition to Price Stability," CDMA Working Paper Series 200402, Centre for Dynamic Macroeconomic Analysis.
  13. Robert E. Lucas, Jr. & N. Gregory Mankiw & Michael Woodford, 2005. "Panel discussion: understanding price determination: where are we now? where should we be going?," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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  15. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
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