Optimal monetary policy with endogenous entry and product variety

• DOI: 10.1016/j.jmoneco.2014.02.006
• Publication Date: 2014-03-18T21:30:43Z
• Authors: Florin O. Bilbiie; Ippei Fujiwara; Fabio Ghironi
• Keywords: Indexation; Deflation; Relative price

Deviations from long-run price stability are optimal in the presence of endogenous entry and product variety in a sticky-price model in which price stability would be optimal otherwise Long-run inflation (deflation) is optimal when the benefit of variety to consumers falls short of (exceeds) the market incentive for creating that variety--the desired markup; Price indexation exacerbates this mechanism. Plausible preference specifications and parameter values justify positive long-run inflation rates. However, short-run price stability (around this non-zero trend) is close to optimal, even in the presence of endogenously time-varying desired markups that distort the intertemporal allocation of resources.