MONETARY POLICY AND COSTS OF PRICE ADJUSTMENT

Abstract: This paper studies the scope for monetary policy in an economy in which firms are concerned by the adverse reaction of their customers to price changes. First, the rational expectations equilibrium of such an economy is computed. Then, it is shown that the preferences of the monetary authority are time incon-sistent as long as it can only respond slowly to changing aggre-gate statistics. The Strotz-Pollack equilibrium of the game between successive monetary authorities is computed and con-trasted both to "optimal " feedback rules and to Friedman's constant growth rule