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Firm-specific capital and welfare

What are the consequences for monetary policy design implied by the fact that price setting and investment takes typically place simultaneously at the firm level? To address this question we analyze simple (constrained) optimal interest rate rules in the context of a dynamic New Keynesian model featuring firm-speci.c capital accumulation as well as sticky prices and wages à la Calvo. We make the case for Taylor type rules. They are remarkably robust in the sense that their welfare implications do not appear to hinge neither on the speci.c assumptions regarding capital accumulation that are used in their derivation nor on the particular definition of natural output that is used to construct the output gap. On the other hand we find that rules prescribing that the central bank does not react to any measure of real economic activity are not robust in that sense.

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Paper provided by Norges Bank in its series Working Paper with number 2006/04.

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Length: 34 pages
Date of creation: 18 Apr 2006
Date of revision:
Handle: RePEc:bno:worpap:2006_04
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  3. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  4. Tommy Sveen & Lutz Weinke, 2004. "New Perspectives on Capital and Sticky Prices," Working Paper 2004/03, Norges Bank.
  5. Dennis, Richard, 2007. "Optimal Policy In Rational Expectations Models: New Solution Algorithms," Macroeconomic Dynamics, Cambridge University Press, vol. 11(01), pages 31-55, February.
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  9. David E. Altig & Lawrence J. Christiano & Martin Eichenbaum & Jesper Linde, 2004. "Firm-specific capital, nominal rigidities, and the business cycle," Working Paper 0416, Federal Reserve Bank of Cleveland.
  10. Rochelle M. Edge, 2003. "A utility-based welfare criterion in a model with endogenous capital accumulation," Finance and Economics Discussion Series 2003-66, Board of Governors of the Federal Reserve System (U.S.).
  11. 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.
  12. Tommy Sveen & Lutz Weinke, 2004. "Pitfalls in the modeling of forward-looking price setting and investment decisions," Economics Working Papers 773, Department of Economics and Business, Universitat Pompeu Fabra.
  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  14. Stephanie Schmitt-Grohe & Martin Uribe, 2005. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model: Expanded Version," NBER Working Papers 11417, National Bureau of Economic Research, Inc.
  15. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices 09-191, Review of Economic Dynamics.
  16. Aoki, Kosuke, 2001. "Optimal monetary policy responses to relative-price changes," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 55-80, August.
  17. Benigno, Pierpaolo, 2001. "Optimal Monetary Policy in a Currency Area," CEPR Discussion Papers 2755, C.E.P.R. Discussion Papers.
  18. Tommy Sveen & Lutz Weinke, 2005. "Is lumpy investment really irrelevant for the business cycle?," Economics Working Papers 869, Department of Economics and Business, Universitat Pompeu Fabra.
  19. Sveen, Tommy & Weinke, Lutz, 2005. "New perspectives on capital, sticky prices, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 123(1), pages 21-39, July.
  20. Michael Woodford, 1996. "Control of the Public Debt: A Requirement for Price Stability?," NBER Working Papers 5684, National Bureau of Economic Research, Inc.
  21. Jordi Galí & Pau Rabanal, 2004. "Technology Shocks and Aggregate Fluctuations; How Well Does the RBC Model Fit Postwar U.S. Data?," IMF Working Papers 04/234, International Monetary Fund.
  22. Lutz Weinke & Tommy Sveen, 2003. "Inflation and output dynamics with firm-owned capital," Economics Working Papers 702, Department of Economics and Business, Universitat Pompeu Fabra.
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