Optimal monetary policy with state-dependent pricing

Anton Nakov and Carlos Thomas

No 2011-48, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: In an abstract economic model, we study optimal monetary policy from the timeless perspective under a general state-dependent pricing framework. We find that when firms are monopolistic competitors subject to idiosyncratic menu cost shocks, households have isoelastic preferences, and there is no government spending, strict price stability is optimal both in the long run and in response to aggregate shocks. Key to this finding is an \"envelope\" property: At zero inflation, a marginal increase in the rate of inflation has no effect on firms' profits and therefore it has no effect on the probability of price adjustment. Our results lend support to more informal statements about the suitability of the Calvo model for studying optimal monetary policy despite its apparent conflict with the Lucas critique. We offer an analytic solution that does not require local approximation or efficiency of the steady state.

Keywords: Monetary policy - Econometric models; Competition (search for similar items in EconPapers)
Date: 2011
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Optimal Monetary Policy with State-Dependent Pricing (2014)
Working Paper: Optimal Monetary Policy with State-Dependent Pricing (2014)
Working Paper: Optimal monetary policy with state-dependent pricing (2011)
Working Paper: Optimal monetary policy with state-dependent pricing (2010)
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