Optimal Monetary Policy with State-Dependent Pricing

43 Pages Posted: 2 Jun 2014

See all articles by Anton Nakov

Anton Nakov

European Central Bank (ECB); CEPR

Carlos Thomas

Banco de España

Multiple version iconThere are 4 versions of this paper

Date Written: February 2014

Abstract

This paper studies optimal monetary policy from the timeless perspective in a general model of state-dependent pricing. Firms are modeled as monopolistic competitors subject to idiosyncratic menu cost shocks. We find that, under certain conditions, a policy of zero inflation 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 hence on their probability of repricing. We offer an analytic solution that does not require local approximation or e¢ ciency of the steady state. Under more general conditions, we show numerically that the optimal commitment policy remains very close to strict inflation targeting.

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

JEL Classification: E31

Suggested Citation

Nakov, Anton A. and Thomas, Carlos, Optimal Monetary Policy with State-Dependent Pricing (February 2014). CEPR Discussion Paper No. DP9846, Available at SSRN: https://ssrn.com/abstract=2444867

Anton A. Nakov (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

CEPR ( email )

London
United Kingdom

Carlos Thomas

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

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

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