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Price setting and the steady-state effects of inflation

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  • Casares, Miguel

Abstract

This paper examines how price setting plays a key role in explaining the steady-state effects of inflation in a monopolistic competition economy. Three pricing variants (optimal prices, indexed prices, and unchanged prices) are introduced through a generalization of the Calvo-type setting that allows the possibility of price indexation, i.e., prices may be adjusted by the rate of inflation. We found that in an economy with less indexed prices the steady-state negative impact of inflation on output is higher. In the extreme case without no price indexation at all (purely Calvo-type economy), unrealistically heavy falls in capital and output were reported when steady-state inflation increases. Regarding welfare analysis, our results support a long-run monetary policy aimed at price stability with a close-to-zero inflation target. This finding is robust to any price setting scenario. JEL Classification: E13, E31, E50

Suggested Citation

  • Casares, Miguel, 2002. "Price setting and the steady-state effects of inflation," Working Paper Series 140, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2002140
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    References listed on IDEAS

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    Cited by:

    1. Levin, Andrew & Yun, Tack, 2007. "Reconsidering the natural rate hypothesis in a New Keynesian framework," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1344-1365, July.
    2. Minford, Patrick & Peel, David, 2004. "Calvo Contracts: A Critique," CEPR Discussion Papers 4288, Centre for Economic Policy Research.
    3. Minford, Patrick & Matthews, Kent & Webb, Bruce & Meenagh, David, 2006. "Monetary Regimes: Is There a Trade-Off Between Consumption and Employment Variability?," CEPR Discussion Papers 5609, Centre for Economic Policy Research.
    4. Minford, Patrick & Nowell, Eric & Webb, Bruce, 2005. "Would price-level targeting destabilise the economy?," Cardiff Economics Working Papers E2005/12, Cardiff University, Cardiff Business School, Economics Section.
    5. Claudio Cesaroni, 2017. "Optimal Long-Run Inflation and the Informal Economy," Bank of Lithuania Working Paper Series 46, Bank of Lithuania.
    6. Patrick Minford & David Peel, 2003. "Optimal monetary policy: is price‐level targeting the next step?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 650-667, November.
    7. Le, Vo Phuong Mai & Minford, Patrick, 2007. "Optimising indexation arrangements under Calvo contracts and their implications for monetary policy," Cardiff Economics Working Papers E2007/7, Cardiff University, Cardiff Business School, Economics Section.
    8. Aguilera-Bravo, Asier & Casares, Miguel, 2019. "On staggered prices and optimal inflation," Economics Letters, Elsevier, vol. 185(C).
    9. Miguel Casares, 2007. "Monopolistic Competition, Sticky Prices, and the Minimal Mark-Up in Steady State," Documentos de Trabajo - Lan Gaiak Departamento de Economía - Universidad Pública de Navarra 0702, Departamento de Economía - Universidad Pública de Navarra.

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    Keywords

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    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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