Optimal Monetary Policy with State-Dependent Pricing

33 Pages Posted: 10 Nov 2011

See all articles by Anton Nakov

Anton Nakov

European Central Bank (ECB); CEPR

Carlos Thomas

Banco de España

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Date Written: November 10, 2011


We study optimal monetary policy from the timeless perspective in a general state-dependent pricing framework. Firms are monopolistic competitors and are subject to idiosyncratic menu cost shocks. We find that, under isoelastic preferences and 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 has no effect on the rate of price adjustment. We offer an analytic solution which does not rely on local approximation or efficiency of the steady-state.

Keywords: monetary policy, state-dependent pricing, monopolistic competition

JEL Classification: E31

Suggested Citation

Nakov, Anton A. and Thomas, Carlos, Optimal Monetary Policy with State-Dependent Pricing (November 10, 2011). Banco de Espana Working Paper No. 1130, Available at SSRN: https://ssrn.com/abstract=1957577 or http://dx.doi.org/10.2139/ssrn.1957577

Anton A. Nakov (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314

CEPR ( email )

United Kingdom

Carlos Thomas

Banco de España ( email )

Alcala 50
Madrid 28014

HOME PAGE: http://www.bde.es

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