Working Paper: CEPR ID: DP2668
Authors: Bernardino Ado; Isabel Correia; Pedro Teles
Abstract: We derive principles of optimal short run monetary policy in a real business cycles model, with money and with monopolistic firms that set prices one period in advance. The only distortionary policy intruments are the nominal interest rates and the money supplies. In this environment it is feasible to undo both the cash in advance and the price setting restrictions. We show that the optimal allocation is achieved under the Friedman rule. We also show that, in general, it is not optimal to undo the restriction that prices are set one period in advance. Sticky prices provide the planner with tools to improve upon a distorted flexible prices allocation.
Keywords: Friedman Rule; Optimal Cyclical Monetary Policy; Prices Set in Advance
JEL Codes: E31; E41; E58; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal interest rates set to zero (E43) | optimal allocation (D61) |
| sticky prices (D41) | improve allocations under flexible prices (D61) |
| nominal interest rates (E43) | economic efficiency (D61) |
| sticky prices (D41) | economic outcomes (F61) |
| elimination of cash-in-advance constraint (E41) | economic efficiency (D61) |