Information Frictions, Monetary Policy, and the Paradox of Price Flexibility
50 Pages Posted: 1 Dec 2020
Date Written: October 23, 2020
The introduction of digital price tags and online shopping may facilitate price adjustments and reduce the degree of nominal rigidity in the economy. Is this welfare-improving? We address this question in a multi-sector New Keynesian model with information frictions and dispersed beliefs. Increased price flexibility may deteriorate welfare through the dispersed beliefs channel and the amplified spillover effects. The dispersed beliefs create a novel channel through which the welfare cost of inflation in a sector increases in price flexibility, altering the optimal inflation target policy. A monetary policy that stabilizes the optimal inflation index mitigates the paradox.
Keywords: Dispersed beliefs, Information Frictions, Spillover Effects, Monetary Policy, Inflation Target, Paradox of Price Flexibility
JEL Classification: E31, E32, E52, E58
Suggested Citation: Suggested Citation