Optimal Monetary Policy with State-Dependent Pricing
by Anton Nakov and Carlos Thomas
Banco de España
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 efficiency of the
steady state. Under more general conditions, we show numerically
that the optimal commitment policy remains very close
to strict inflation targeting.
JEL Codes: E31.
Full article (PDF, 46 pages, 709 kb)