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The Long-run Output-inlation Trade-off with Menu Costs

Wai-Yip Alex Ho

Hong Kong Monetary Authority

James Yetman

Bank for International Settlements (BIS)

August 2005

We examine the long-run output-inflation trade-off under the assumption that firms face menu costs and set prices in a state dependent fashion. We argue that these characteristics capture the idea that the long-run output-inflation trade-off is driven by (predictable) trend inflation, and the degree of price rigidity should be chosen optimally by firms in the long run, at least on average. We find that state dependent pricing implies a non-trivial departure from long-run monetary neutrality in terms of output, and a larger one in terms of utility. This is because trend inflation substantially influences average mark-ups and relative price distortions. We find that price stability is optimal.

Number of Pages in PDF File: 29

JEL Classification: E3

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Date posted: August 17, 2005  

Suggested Citation

Ho, Wai-Yip Alex and Yetman, James, The Long-run Output-inlation Trade-off with Menu Costs (August 2005). Available at SSRN: https://ssrn.com/abstract=780824 or http://dx.doi.org/10.2139/ssrn.780824

Contact Information

Wai-Yip Alex Ho
Hong Kong Monetary Authority ( email )
Hong Kong Monetary Authority
55/F, 2 International Finance Centre, 8 Finance St
Hong Kong
James Yetman (Contact Author)
Bank for International Settlements (BIS) ( email )
Centralbahnplatz 2
Basel, Basel-Stadt 4002
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