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Monetary Stabilization Policy in a Dynamic Stochastic Menu Cost Model

Author

Listed:
  • Claus Thustrup Hansen

    (Institute of Economics, University of Copenhagen)

Abstract

This paper analyses systematic monetary policy in a dynamic stochastic menu cost model. The main assumptions are that price setters have to pay small adjustment costs in order to equalize actual and optimal prices whereas the central bank can do so costlessly (by adjusting the money supply) but only with a lag. It is shown that a simple (static optimal) policy that fully counteracts all shocks may reduce welfare. The policy reduces the consequences of small shocks but increases the band of inaction of the price setters. This feed-back effect on price setters increases the amount of price rigidity and reduces welfare. In fact, a socially optimal monetary policy may involve a commitment to enhance large shocks.

Suggested Citation

  • Claus Thustrup Hansen, 1998. "Monetary Stabilization Policy in a Dynamic Stochastic Menu Cost Model," Discussion Papers 98-18, University of Copenhagen. Department of Economics.
    • Handle: RePEc:kud:kuiedp:9818
    as

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    More about this item

    Keywords

    monetary policy; menu costs; intertemporal maximization;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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