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

29 Pages Posted: 17 Aug 2005  

Wai-Yip Alex Ho

Hong Kong Monetary Authority

James Yetman

Bank for International Settlements (BIS)

Date Written: August 2005

Abstract

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.

JEL Classification: E3

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

Wai-Yip Alex Ho

Hong Kong Monetary Authority ( email )

Hong Kong Monetary Authority
55/F, 2 International Finance Centre, 8 Finance St
Central
Hong Kong

James Yetman (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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