Information frictions, monetary policy, and the paradox of price flexibility
•Reduction in nominal rigidity does not necessarily improve welfare.•Increased price flexibility may decrease welfare through the dispersed belief channel.•Increased price flexibility may decrease welfare through the amplified spillover effects.•Dispersed beliefs alter the optimal inflation index st...
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| Published in: | Journal of monetary economics Vol. 120; pp. 70 - 82 |
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| Format: | Journal Article |
| Language: | English |
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01-05-2021
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| Abstract | •Reduction in nominal rigidity does not necessarily improve welfare.•Increased price flexibility may decrease welfare through the dispersed belief channel.•Increased price flexibility may decrease welfare through the amplified spillover effects.•Dispersed beliefs alter the optimal inflation index stabilization policy.•A monetary policy that stabilizes the optimal inflation index mitigates the paradox.
The introduction of digital price tags and e-commerce facilitates the implementation of price adjustments and thereby diminishes the degree of nominal rigidity in an economy. Is this phenomenon welfare-improving? We address this question using a multi-sector New Keynesian model with information frictions and dispersed beliefs. Increased price flexibility may decrease welfare through the dispersed belief channel and the amplified spillover effects. Dispersed beliefs create a novel channel through which the welfare cost of inflation in a sector increases with price flexibility, altering the optimal inflation index stabilization policy. A monetary policy that stabilizes the optimal inflation index mitigates this paradox. |
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| AbstractList | •Reduction in nominal rigidity does not necessarily improve welfare.•Increased price flexibility may decrease welfare through the dispersed belief channel.•Increased price flexibility may decrease welfare through the amplified spillover effects.•Dispersed beliefs alter the optimal inflation index stabilization policy.•A monetary policy that stabilizes the optimal inflation index mitigates the paradox.
The introduction of digital price tags and e-commerce facilitates the implementation of price adjustments and thereby diminishes the degree of nominal rigidity in an economy. Is this phenomenon welfare-improving? We address this question using a multi-sector New Keynesian model with information frictions and dispersed beliefs. Increased price flexibility may decrease welfare through the dispersed belief channel and the amplified spillover effects. Dispersed beliefs create a novel channel through which the welfare cost of inflation in a sector increases with price flexibility, altering the optimal inflation index stabilization policy. A monetary policy that stabilizes the optimal inflation index mitigates this paradox. |
| Author | Zhang, Donghai Zhang, Renbin Ou, Shengliang |
| Author_xml | – sequence: 1 givenname: Shengliang orcidid: 0000-0001-9190-108X surname: Ou fullname: Ou, Shengliang email: shengliang.ou@gmail.com organization: Institute for Advanced Research, Shanghai University of Finance and Economics, Shanghai, 200433, China – sequence: 2 givenname: Donghai orcidid: 0000-0003-0141-809X surname: Zhang fullname: Zhang, Donghai email: donghai.zhang@uni-bonn.de organization: Institute for Macroeconomics and Econometrics, University of Bonn, Adenauerallee, 53113, Germany – sequence: 3 givenname: Renbin surname: Zhang fullname: Zhang, Renbin email: zhang.renbin.ken@gmail.com organization: School of Economics, Shandong University, Jinan, 250100, China |
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| Cites_doi | 10.1257/aer.99.3.769 10.1257/jel.20171300 10.1111/j.1467-937X.2009.00566.x 10.1016/S0304-3932(03)00029-1 10.1111/obes.12381 10.1257/aer.20110306 10.1016/j.jmoneco.2009.06.012 10.1086/665662 10.1257/aer.20171066 10.1162/154247603770383398 10.1257/aer.20131658 10.1257/aer.99.5.2050 10.1257/aer.20110865 10.1257/aer.20161996 10.1257/aer.20170519 10.1016/j.jmoneco.2007.12.008 10.1016/j.jmoneco.2005.08.020 10.1257/aer.20131513 10.1093/jeea/jvy009 10.1257/aer.20141127 10.1016/j.jmoneco.2004.08.008 10.1093/restud/rdt024 10.1016/j.jmoneco.2009.06.013 10.1016/j.jmoneco.2005.03.002 10.1016/j.jmoneco.2015.06.006 10.1016/j.jmoneco.2018.07.006 10.1016/j.jmoneco.2016.08.007 10.1016/j.jmoneco.2009.07.001 10.1016/S0304-3932(01)00069-1 10.1111/jeea.12032 10.1016/0022-0531(72)90142-1 10.1162/003355302320935034 10.1162/qjec.2008.123.4.1415 10.1016/S0022-1996(03)00055-2 |
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| Keywords | E31 Paradox of price flexibility E52 E32 Spillover effects Information frictions Monetary policy New keynesian model E58 |
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