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Optimal monetary policy with state-dependent pricing

  • Anton Nakov

    ()

    (Banco de España and ECB)

  • Carlos Thomas

    ()

    (Banco de España)

We study optimal monetary policy from the timeless perspective in a general state-dependent pricing framework. Firms are monopolistic competitors and are subject to idiosyncratic menu cost shocks. We find that, under isoelastic preferences and no government spending, strict price stability is optimal both in the long run and in response to aggregate shocks. Key to this finding is an “envelope” property: at zero inflation, a marginal increase in the rate of inflation has no effect on firms’ profits and therefore has no effect on the rate of price adjustment. We offer an analytic solution which does not rely on local approximation or efficiency of the steady-state.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/11/Fich/dt1130e.pdf
File Function: First version, November 2011
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1130.

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Length: 36 pages
Date of creation: Nov 2011
Date of revision:
Handle: RePEc:bde:wpaper:1130
Contact details of provider: Web page: http://www.bde.es/
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  1. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
  2. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March.
  3. Anton Nakov & Carlos Thomas, 2011. "Optimal monetary policy with state-dependent pricing," Finance and Economics Discussion Series 2011-48, Board of Governors of the Federal Reserve System (U.S.).
  4. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  5. Bakhshi, Hasan & Khan, Hashmat & Rudolf, Barbara, 2007. "The Phillips curve under state-dependent pricing," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2321-2345, November.
  6. Peter J. Klenow & Oleksiy Kryvtsov, 2008. "State-Dependent or Time-Dependent Pricing: Does It Matter for Recent U.S. Inflation?," The Quarterly Journal of Economics, MIT Press, vol. 123(3), pages 863-904, August.
  7. James Costain & Anton Nakov, 2011. "Price Adjustments in a General Model of State‐Dependent Pricing," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 385-406, 03.
  8. Denny Lie, 2009. "State-dependent pricing and optimal monetary policy," Working Papers 09-20, Federal Reserve Bank of Boston.
  9. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 655-690, May.
  10. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
  11. Robert Lucas & Mike Golosov, 2004. "Menu Costs and Phillips Curves," 2004 Meeting Papers 144, Society for Economic Dynamics.
  12. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  13. Virgiliu Midrigan, 2011. "Menu Costs, Multiproduct Firms, and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 79(4), pages 1139-1180, 07.
  14. Michael Reiter, 2006. "Solving heterogeneous-agent models by projection and perturbation," Economics Working Papers 972, Department of Economics and Business, Universitat Pompeu Fabra.
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