Optimal Monetary Policy with Endogenous Entry and Product Variety

54 Pages Posted: 16 Sep 2011

See all articles by Florin Ovidiu Bilbiie

Florin Ovidiu Bilbiie

University of Oxford

Ippei Fujiwara

Australian National University (ANU) - Crawford School of Public Policy

Fabio Pietro Ghironi

University of Washington

Date Written: September 2011

Abstract

We show that deviations from long-run stability of product prices are optimal in the presence of endogenous producer entry and product variety in a sticky-price model with monopolistic competition in which price stability would be optimal in the absence of entry. Specifically, a long-run positive (negative) rate of inflation is optimal when the benefit of variety to consumers falls short of (exceeds) the market incentives for creating that variety under flexible prices, governed by the desired markup. Plausible preference specifications and parameter values justify a long-run inflation rate of two percent or higher. Price indexation implies even larger deviations from long-run price stability. However, price stability (around this non-zero trend) is close to optimal in the short run, even in the presence of time-varying flexible-price markups that distort the allocation of resources across time and states. The central bank uses its leverage over real activity in the long run, but not in the short run. Our results point to the need for continued empirical research on the determinants of markups and investigation of the benefit of product variety to consumers.

Keywords: Entry, Optimal inflation rate, Price stability, Product variety, Ramsey-optimal monetary policy.

JEL Classification: E31, E32, E52

Suggested Citation

Bilbiie, Florin Ovidiu and Fujiwara, Ippei and Ghironi, Fabio Pietro, Optimal Monetary Policy with Endogenous Entry and Product Variety (September 2011). CEPR Discussion Paper No. DP8565, Available at SSRN: https://ssrn.com/abstract=1928448

Florin Ovidiu Bilbiie (Contact Author)

University of Oxford ( email )

Oxford
United Kingdom

Ippei Fujiwara

Australian National University (ANU) - Crawford School of Public Policy ( email )

ANU College of Asia and the Pacific
J.G. Crawford Building #132 Lennox Crossing
Canberra, Australian Capital Territory 0200
Australia

Fabio Pietro Ghironi

University of Washington ( email )

Department of Economics
Box 353330
Seattle, WA 98195-3330
United States
206-543-5795 (Phone)

HOME PAGE: http://faculty.washington.edu/ghiro

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