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Optimal Monetary Policy with a Flexible Price-setting Rule
Credit and Capital Markets – Kredit und Kapital, Vol. 18 (1985), Iss. 3 : pp. 289–298
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David Nickerson, Vancouver
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Abstract
Optimal Monetary Policy with a Flexible Price-setting Rule
The neutrality of systematic monetary policy is examined in a representative macroeconomic model featuring a flexible price-setting rule that encompasses both an equilibrium price, as found in Sargent and Wallace (1975) and two-period price rigidity, as found in Fischer (1977), Phelps and Taylor (1977) and others, as special cases. Systematic monetary policy is shown to influence real output for a continuum of non-equilibrium prices arbitrarily close to the equilibrium price, indicating that monetary policy may have a stabilizing role in an economy with almost complete price flexibility. An optimal monetary policy which minimizes both output and price variance is derived and shown to have an impact on output that is linearly decreasing in a measure of price flexibility. The parameters of this policy are independent of the measure of price flexibility, implying a potentially significant saving in information costs to the monetary authority.