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Nominal frictions, relative price adjustment, and the limits to monetary policy

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  • Alexander L. Wolman

Abstract

In simple sticky-price models, the guiding principle for optimal monetary policy is to stabilize nominal prices so as to eliminate the distortions associated with price adjustment. If there is only one sector, or one category of consumption goods, then stabilizing nominal prices means making the inflation rate zero. A growing subliterature on sticky prices considers optimal monetary policy when there are multiple sectors of sticky-price goods, broadly defined. If the relative prices of these goods need to move over time, then the principle just stated cannot be satisfied for all goods. Here I sketch some theoretical models to clarify the issues involved and use data for the United States to suggest that these issues are not mere theoretical curiosities.

Suggested Citation

  • Alexander L. Wolman, 2008. "Nominal frictions, relative price adjustment, and the limits to monetary policy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 219-233.
  • Handle: RePEc:fip:fedreq:y:2008:i:sum:p:219-233:n:v.94no.3
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    References listed on IDEAS

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    3. Emi Nakamura & Jón Steinsson, 2010. "Monetary Non-neutrality in a Multisector Menu Cost Model," The Quarterly Journal of Economics, Oxford University Press, vol. 125(3), pages 961-1013.
    4. Robert King & Alexander L. Wolman, 1999. "What Should the Monetary Authority Do When Prices Are Sticky?," NBER Chapters,in: Monetary Policy Rules, pages 349-404 National Bureau of Economic Research, Inc.
    5. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    6. Marvin Goodfriend & Robert King, 1997. "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 231-296 National Bureau of Economic Research, Inc.
    7. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters,in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
    8. Erceg, Christopher & Levin, Andrew, 2006. "Optimal monetary policy with durable consumption goods," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1341-1359, October.
    9. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, vol. 63(2), pages 293-320, July.
    10. Alexander L. Wolman, 1999. "Sticky prices, marginal cost, and the behavior of inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 29-48.
    11. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
    12. Huang, Kevin X.D. & Liu, Zheng, 2005. "Inflation targeting: What inflation rate to target?," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1435-1462, November.
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    Cited by:

    1. Gerberding, Christina & Gerke, Rafael & Hammermann, Felix, 2012. "Price-level targeting when there is price-level drift," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 757-768.
    2. Sevim Kosem Alp, 2010. "Optimal Monetary Policy under Sectoral Heterogeneity in Inflation Persistence (Sektorel Enflasyon Ataleti Farkliligi Altinda Optimal Para Politikasi)," Working Papers 1004, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    3. Gerberding, Christina & Gerke, Rafael & Hammermann, Felix, 2010. "Price-level targeting when there is price-level drift," Discussion Paper Series 1: Economic Studies 2010,23, Deutsche Bundesbank.

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    Keywords

    Monetary policy ; Prices;

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