Monetary and Fiscal Policy with Flexible Exchange Rates

Abstract

If price decisions are taken neither continuously nor in perfect synchronization, the process of adjustment of all prices to a new nominal level will imply temporary movements in relative prices. It might then well be that, to avoid these movements in relative prices, each price setter will want to move his own price slowly compared to others. The result will be a slow movement of all prices to their new nominal level, and substantial inertia of the price level. This paper formalizes this intuitive argument and reaches four main conclusions: (1) Even small departures from perfect synchronization can generate substantial price level inertia. (2) If price decisions are desynchronized, even anticipated movements in money will usually have an effect on economic activity. It is however possible to find paths of money deceleration which reduce inflation at no cost in output. (3) Price desynchronization has implications for relative price movements as well as for the price level. Goods early in the chain of production have more price and profit variability than goods further down the chain. (4) Price inertia, if it is due to price desynchronization, may be difficult to remove. It may well be that, given the timing decisions of others, no agent has an incentive to change his own timing decision: the time structure of price desynchronization may be stable.