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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
Download Restriction: no

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. 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.
  2. Pierpaolo Benigno & Michael Woodford, 2004. "Inflation stabilization and welfare: The case of a distorted steady state," Discussion Papers 0405-04, Columbia University, Department of Economics.
  3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  4. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March.
  5. 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.
  6. Denny Lie, 2009. "State-dependent pricing and optimal monetary policy," Working Papers 09-20, Federal Reserve Bank of Boston.
  7. Rudolf, B. & Bakhshi, H., 2005. "The Phillips Curve Under State-Dependent Pricing," Computing in Economics and Finance 2005 68, Society for Computational Economics.
  8. Robert Lucas & Mike Golosov, 2004. "Menu Costs and Phillips Curves," 2004 Meeting Papers 144, Society for Economic Dynamics.
  9. Peter J. Klenow & Oleksiy Kryvtsov, 2007. "State-Dependent or Time-Dependent Pricing: Does It Matter for Recent U.S. Inflation?," Discussion Papers 07-007, Stanford Institute for Economic Policy Research.
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