Optimal Policies When Price Fairness Matters

This paper presents an analysis of optimal policies within a New Keynesian model that incorporates households’ concerns regarding fair price markups. Fluctuations in inflation shape perceptions of fairness, which constitute a pivotal factor in the design of policies. The optimal fiscal policy is an income subsidy designed to address inefficiencies resulting from price markups; however, it is ineffective in mitigating households’ perceptions of fair pricing. In the event that inflation targeting by the monetary authority is not sufficiently strict, the optimal policy shifts to a tax. The planner is thus able to mitigate both demanddriven inflation and concerns regarding the fairness of pricing, albeit at the cost of welfare losses. Furthermore, an analogous policy to price caps is examined, in which the planner determines an optimal markup path for firms in lieu of providing subsidies to households. This approach is demonstrated to be equivalent to a subsidy within this framework. Consequently, when fairness and inflationary pressures are relatively low to moderate, a price markup cap is an effective means of enhancing welfare. However, as these factors intensify, the planner sets a high markup, resulting in welfare losses.