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Information frictions, monetary policy, and the paradox of price flexibility

Shengliang Ou, Donghai Zhang and Renbin Zhang

Journal of Monetary Economics, 2021, vol. 120, issue C, 70-82

Abstract: The introduction of digital price tags and e-commerce facilitates the implementation of price adjustments and thereby diminishes the degree of nominal rigidity in an economy. Is this phenomenon welfare-improving? We address this question using a multi-sector New Keynesian model with information frictions and dispersed beliefs. Increased price flexibility may decrease welfare through the dispersed belief channel and the amplified spillover effects. Dispersed beliefs create a novel channel through which the welfare cost of inflation in a sector increases with price flexibility, altering the optimal inflation index stabilization policy. A monetary policy that stabilizes the optimal inflation index mitigates this paradox.

Keywords: New keynesian model; Information frictions; Spillover effects; Monetary policy; Paradox of price flexibility (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 E58 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.jmoneco.2021.03.005

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