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Welfare loss and policy trade-offs: Calvo vs. Rotemberg

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  • Oh, Joonseok

Abstract

This paper shows that the Calvo and Rotemberg pricing models lead to different outcomes regarding welfare losses and inflation-output dynamics, based on the type of subsidies used to achieve an efficient steady state. When revenue subsidies are applied in the Rotemberg model, the inflation-output dynamics and welfare loss functions are identical to those of the Calvo model. However, with employment subsidies, the two models differ. Aligning the inflation-output dynamics causes differences in the welfare loss function. These findings underscore the importance of model selection in the design of monetary policy, influencing the trade-off between inflation and output gap stabilisation.

Suggested Citation

  • Oh, Joonseok, 2025. "Welfare loss and policy trade-offs: Calvo vs. Rotemberg," Economics Letters, Elsevier, vol. 249(C).
    • Handle: RePEc:eee:ecolet:v:249:y:2025:i:c:s0165176525000813
    DOI: 10.1016/j.econlet.2025.112244
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    References listed on IDEAS

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    1. Bonciani, Dario & Oh, Joonseok, 2025. "Optimal monetary policy mix at the zero lower bound," Journal of Economic Dynamics and Control, Elsevier, vol. 170(C).
    2. Sushant Acharya & Edouard Challe & Keshav Dogra, 2023. "Optimal Monetary Policy According to HANK," American Economic Review, American Economic Association, vol. 113(7), pages 1741-1782, July.
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    4. Lombardo, Giovanni & Vestin, David, 2008. "Welfare implications of Calvo vs. Rotemberg-pricing assumptions," Economics Letters, Elsevier, vol. 100(2), pages 275-279, August.
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    6. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(3), pages 707-734.
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    Keywords

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    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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