Stabilisation bias in monetary policy under endogenous price stickiness

Abstract

This paper investigates the consequences of introducing endogenous price stickiness into a standard monetary policy model.We find that the modification reduces the optimal degree of inflation stabilization to which the central bank should commit.The reason is that less inflation stabilization encourages firms to review their prices more frequently.The economy becomes more flexible and the Phillips-curve tradeoff is improved, making it easier for the central bank to control inflation.This reduces, and may even reverse, the stabilization bias that is present in models with exogenous price stickiness and that recommends that the central bank generally commit to tighter stabilization of inflation than it would in a discretionary policy regime.Key words: price stickiness, monetary policy, stabilization bias