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Optimal monetary policy with state-dependent pricing

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  • Nakov, Anton
  • Thomas, Carlos

Abstract

We study optimal monetary policy in a flexible state-dependent pricing framework, in which monopolistic competition and stochastic menu costs are the only distortions. We show analytically that it is optimal to commit to zero inflation in the long run. Moreover, our numerical simulations indicate that the optimal stabilization policy is "price stability". These findings represent a generalization to a state-dependent framework of the same results found for the simple Calvo model with exogenous timing of price adjustment. JEL Classification: E31

Suggested Citation

  • Nakov, Anton & Thomas, Carlos, 2010. "Optimal monetary policy with state-dependent pricing," Working Paper Series 1250, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20101250
    Note: 374708
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    References listed on IDEAS

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    1. 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.
    2. 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, Oxford University Press, vol. 123(3), pages 863-904.
    3. 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, Oxford University Press, vol. 114(2), pages 655-690.
    4. 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.
    5. Anton Nakov & Carlos Thomas, 2014. "Optimal Monetary Policy with State-Dependent Pricing," International Journal of Central Banking, International Journal of Central Banking, vol. 10(3), pages 49-94, September.
    6. 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.
    7. Reiter, Michael, 2009. "Solving heterogeneous-agent models by projection and perturbation," Journal of Economic Dynamics and Control, Elsevier, vol. 33(3), pages 649-665, March.
    8. Caballero, Ricardo J. & Engel, Eduardo M.R.A., 2007. "Price stickiness in Ss models: New interpretations of old results," Journal of Monetary Economics, Elsevier, vol. 54(Supplemen), pages 100-121, September.
    9. Mikhail Golosov & Robert E. Lucas Jr., 2007. "Menu Costs and Phillips Curves," Journal of Political Economy, University of Chicago Press, vol. 115, pages 171-199.
    10. Denny Lie, 2009. "State-dependent pricing and optimal monetary policy," Working Papers 09-20, Federal Reserve Bank of Boston, revised 2009.
    11. Virgiliu Midrigan, 2011. "Menu Costs, Multiproduct Firms, and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 79(4), pages 1139-1180, July.
    12. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, Oxford University Press, vol. 123(4), pages 1415-1464.
    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. 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.
    15. 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(2‐3), pages 385-406, March.
    16. Tack Yun, 2005. "Optimal Monetary Policy with Relative Price Distortions," American Economic Review, American Economic Association, vol. 95(1), pages 89-109, March.
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    Citations

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    Cited by:

    1. Anton Nakov & Carlos Thomas, 2014. "Optimal Monetary Policy with State-Dependent Pricing," International Journal of Central Banking, International Journal of Central Banking, vol. 10(3), pages 49-94, September.
    2. Denny Lie, 2009. "State-dependent pricing and optimal monetary policy," Working Papers 09-20, Federal Reserve Bank of Boston, revised 2009.
    3. Shuhei Takahashi, 2018. "Does State-Dependent Wage Setting Generate Multiple Equilibria?," KIER Working Papers 991, Kyoto University, Institute of Economic Research.
    4. Muhammad Ali Nasir & Milton Yago & Alaa M. Soliman & Junjie Wu, 2016. "Financial stability, wealth effects and optimal macroeconomic policy combination in the United Kingdom: A new-Keynesian dynamic stochastic general equilibrium framework," Cogent Economics & Finance, Taylor & Francis Journals, vol. 4(1), pages 1136098-113, December.
    5. Shuhei Takahashi, 2017. "State Dependency in Price and Wage Setting," International Journal of Central Banking, International Journal of Central Banking, vol. 13(1), pages 151-189, February.
    6. Kosuke Aoki, 2015. "Relative Prices and Inflation Stabilization," The Japanese Economic Review, Japanese Economic Association, vol. 66(1), pages 35-59, March.

    More about this item

    Keywords

    optimal monetary policy; price stability; state-dependent pricing; stochastic menu costs;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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