Working Paper

Optimal monetary policy, endogenous sticky prices and multiplicity of equilibria

Abstract: We analyze optimal discretionary monetary policy in an endogenous sticky prices model. Similar models with exogenous sticky prices can deliver multiple equilibria. This is a necessary condition for the occurrence of expectation traps (when private agents? expectations determine the equilibrium level of inflation). In our model, sticky price firms are allowed to switch to flexible pricing by paying a random cost. For plausible parametrizations, our model has a unique low-inflation equilibrium. With endogenous sticky prices, the monetary authority does not validate high-inflation expectations and deviates to the Friedman rule.

Keywords: Monetary policy; Prices;

Status: Published in Topics in Macroeconomics, January 2007, 7(1), Article 8

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2007

Number: 2005-036