Monopolistic Price Adjustment and The Effectiveness of Anticipated Money

This paper examines the effectiveness of anticipated monetary policy under a monopolistic price adjustment rgule based on profit maximizing behavior. Sargent and Wallace (1975) demonstrated that anticipated monetary policy does not have an effect on real output if markets are perfectly competitive and expectations are formed rationally. This paper shows how, under a monopolistic price adjustment rule, an expected change of the money stock can affect real output through its effects on real money balances and the relative prices of foreign goods. An aggregate price adjustment rule is derived from the monopolistically competitive firm's profit maximizing behavior when nominal wages are determined competitively. The monopolistic price adjustment rule shows how prices do not adjust equiproportionately to a change of the money stock. This nonequi proportionate adjustment of prices in response to a change of the money stock accounts for the real balance effect. Moreover, this paper shows that an expected change of the money stock affects relative prices of foreign goods through the effect on the foreign demand for domestic output and affects domestic real output.