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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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