Optimal Inflation, Average Markups and Asymmetric Sticky Prices

Abstract

In the Eurozone price stickiness differs among countries. I explore its consequences on the optimal rate of inflation in a two-country model. On the one hand, with local currencies an inflation tax is partly imposed on the foreign country, so it creates incentives to inflate. On the other hand, the average markup constitutes a cost of holding money, so it creates incentives to deflate. The paper presents four findings: i) with local currencies, the first motive dominates and the optimal inflation is positive, ii) in a monetary union the first motive is absent and the optimal inflation is negative and below the Friedman rule, iii) a monetary union improves global welfare even when stickiness is different in two countries. In this, the paper contributes to the literature on the optimality of monetary unions by evaluating unions with asymmetric price stickiness.

Keywords: monetary union, inflation, monetary policy

JEL Classification: E52, F41, F42