Monetary Stabilization Policy in a Dynamic Stochastic Menu Cost Model

Claus Thustrup Hansen
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Claus Thustrup Hansen: Institute of Economics, University of Copenhagen
Authors registered in the RePEc Author Service: Claus Thustrup Kreiner

No 98-18, Discussion Papers from University of Copenhagen. Department of Economics

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.

Keywords: monetary policy; menu costs; intertemporal maximization (search for similar items in EconPapers)
JEL-codes: E32 E52 (search for similar items in EconPapers)
Pages: 21 pages
Date: 1998-12
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Persistent link: https://EconPapers.repec.org/RePEc:kud:kuiedp:9818

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