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Time consistent monetary policy with endogenous price rigidity

  • Henry E. Siu

I characterize time consistent equilibrium in an economy with price rigidity and an optimizing> monetary authority operating under discretion. Firms have the option to increase their frequency> of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant> degree of price rigidity across inflation regimes, find two time consistent equilibria ? one with low> inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high> inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result> depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost> of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of> price rigidity.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 390.

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Date of creation: 2007
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Handle: RePEc:fip:fedmsr:390
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  3. Henry Siu & Michael B. Devereux, 2004. "State Dependent Pricing and Business Cycle Asymmetries," 2004 Meeting Papers 161, Society for Economic Dynamics.
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  13. Chari, V V & Kehoe, Patrick J, 1993. "Sustainable Plans and Mutual Default," Review of Economic Studies, Wiley Blackwell, vol. 60(1), pages 175-95, January.
  14. Stefania Albanesi & V.V. Chari & Lawrence J. Christiano, 2001. "How Severe is the Time Inconsistency Problem in Monetary Policy?," NBER Working Papers 8139, National Bureau of Economic Research, Inc.
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  25. repec:nbr:nberre:0126 is not listed on IDEAS
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