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Optimal Monetary Policy with Endogenous Entry and Product Variety

  • Bilbiie, Florin Ovidiu
  • Fujiwara, Ippei
  • Ghironi, Fabio

We show that deviations from long-run stability of product prices are optimal in the presence of endogenous producer entry and product variety in a sticky-price model with monopolistic competition in which price stability would be optimal in the absence of entry. Specifically, a long-run positive (negative) rate of inflation is optimal when the benefit of variety to consumers falls short of (exceeds) the market incentives for creating that variety under flexible prices, governed by the desired markup. Plausible preference specifications and parameter values justify a long-run inflation rate of two percent or higher. Price indexation implies even larger deviations from long-run price stability. However, price stability (around this non-zero trend) is close to optimal in the short run, even in the presence of time-varying flexible-price markups that distort the allocation of resources across time and states. The central bank uses its leverage over real activity in the long run, but not in the short run. Our results point to the need for continued empirical research on the determinants of markups and investigation of the benefit of product variety to consumers.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8565.

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Date of creation: Sep 2011
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Handle: RePEc:cpr:ceprdp:8565
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  1. 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.
  2. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
  3. Sanjay K. Chugh, 2006. "Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 683-714, October.
  4. V. Lewis, 2009. "Optimal Monetary Policy and Firm Entry," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 09/604, Ghent University, Faculty of Economics and Business Administration.
  5. Isabel Correia & Juan Pablo Nicolini & Pedro Teles, 2002. "Optimal fiscal and monetary policy: equivalence results," Working Paper Series WP-02-16, Federal Reserve Bank of Chicago.
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  8. Fabio Ghironi & Sanjay K. Chugh, 2010. "Optimal Fiscal Policy with Endogenous Product Variety," 2010 Meeting Papers 812, Society for Economic Dynamics.
  9. Benassy, Jean-Pascal, 1991. "Monopolistic competition," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 37, pages 1997-2045 Elsevier.
  10. Ester Faia, 2009. "Oligopolistic Competition and Optimal Monetary Policy," Kiel Working Papers 1552, Kiel Institute for the World Economy.
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  12. KIM, Jinill & RUGE-MURCIA, Francisco J., 2007. "How Much Inflation is Necessary to Grease the Wheels?," Cahiers de recherche 11-2007, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  13. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 575-607, April.
  14. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  15. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2007. "Monetary Policy and Business Cycles with Endogenous Entry and Product Variety," NBER Working Papers 13199, National Bureau of Economic Research, Inc.
  16. Robert J. Gordon, 2006. "The Boskin Commission Report: A Retrospective One Decade Later," NBER Working Papers 12311, National Bureau of Economic Research, Inc.
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  18. Florin O. Bilbiie & Fabio Ghironi & Marc J. Melitz, 2008. "Monopoly Power and Endogenous Product Variety: Distortions and Remedies," NBER Working Papers 14383, National Bureau of Economic Research, Inc.
  19. Roberto M. Billi, 2007. "Optimal inflation for the U.S," Research Working Paper RWP 07-03, Federal Reserve Bank of Kansas City.
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