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Destabilising Stabilisation Policy in a Dynamic Menu Cost Model

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  • Hansen, Per Svejstrup

Abstract

This paper analyses how systematic stabilisation policy by monetary authorities may change individual price adjustment decision. The model is a stochastic dynamic menu cost model that results in (S,s)-price rules where the price is fixed inside a band. The resulting price rigidity causes output to fluctuate, and hence there is room for stabilisation policy. This paper shows that such a policy might actually be destabilising in the sense that the zone of fixed prices widens, leading to larger output fluctuations. In fact, output can be completely stabilised by a policy that amplifies shocks.

Suggested Citation

  • Hansen, Per Svejstrup, 2001. "Destabilising Stabilisation Policy in a Dynamic Menu Cost Model," Unit of Economics Working Papers 24206, Royal Veterinary and Agricultural University, Food and Resource Economic Institute.
    • Handle: RePEc:ags:rvaewp:24206
    DOI: 10.22004/ag.econ.24206
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    References listed on IDEAS

    as
    1. N. Gregory Mankiw, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 100(2), pages 529-538.
    2. Andrew S. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(4), pages 703-725.
    3. Andrew Caplin & John Leahy, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(3), pages 683-708.
    4. Ricardo J. Caballero & Eduardo M. R. A. Engel, 1993. "Heterogeneity and Output Fluctuations in a Dynamic Menu-Cost Economy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(1), pages 95-119.
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