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Time consistent monetary policy with endogenous price rigidity

  • Siu, Henry E.

I characterize time consistent equilibrium in an economy with price rigidity and an optimizing> monetary authority operating under discretion. Firms have the option to increase their frequency> of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant> degree of price rigidity across inflation regimes, find two time consistent equilibria ? one with low> inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high> inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result> depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost> of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of> price rigidity.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 138 (2008)
Issue (Month): 1 (January)
Pages: 184-210

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Handle: RePEc:eee:jetheo:v:138:y:2008:i:1:p:184-210
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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