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The long-run output-inflation trade-off in the presence of menu costs

Author

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  • James Yetman
  • Wai Yip Alex Ho

    () (School of Economics and Finance University of Hong Kong)

Abstract

We examine the long-run output-inflation trade-off under the assumption that firms face menu costs and set prices in a state dependent fashion. We argue that these characteristics capture the idea that the long-run output-inflation trade-off is driven by (predictable) trend inflation, and the degree of price rigidity should be chosen optimally by firms in the long run, at least on average. We find that state dependent pricing implies a non-trivial departure from long-run monetary neutrality in terms of output, and a larger one in terms of utility. This is because trend inflation substantially influences average mark-ups, relative price distortions, and resources required for changing prices. The optimal level of long-run inflation is zero.

Suggested Citation

  • James Yetman & Wai Yip Alex Ho, 2005. "The long-run output-inflation trade-off in the presence of menu costs," Computing in Economics and Finance 2005 31, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:31
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    Keywords

    State Dependent Pricing; Menu Costs; Phillips Curve;

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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