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The long-run output-inflation trade-off with menu costs

  • Alex Ho, Wai-Yip
  • Yetman, James

We examine the long-run output-inflation trade-off under the assumption that firms face menu costs and set prices in a state dependent fashion. We argue that these characteristics capture the idea that the long-run output-inflation trade-off is driven by (predictable) trend inflation, and the degree of price rigidity should be chosen optimally by firms in the long run, at least on average. We find that state dependent pricing implies a non-trivial departure from long-run monetary neutrality in terms of output, and a larger one in terms of utility. This is because trend inflation substantially influences average mark-ups and relative price distortions. We find that price stability is optimal.

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Article provided by Elsevier in its journal The North American Journal of Economics and Finance.

Volume (Year): 19 (2008)
Issue (Month): 3 (December)
Pages: 261-273

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Handle: RePEc:eee:ecofin:v:19:y:2008:i:3:p:261-273
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