Working Paper Alfred P. Sloan School of Management Monetary Policy and Costs of Price Adjustment Monetary Policy and Costs of Price Adjustment Monetary Policy and Costs of Price Adjustment Helpful Comments and Suggestions

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 inconsistent as long as it can only respond slowly to changing aggregate statistics. The Strotz-Pollack equilibrium of the game between successive monetary authorities is computed and contrasted both to "optimal" feedback rules and to Friedman's constant growth rule. Assistant Professor, Sloan School of Management, Massachusetts Institute of Technology. This paper is a revised version of Chapter III of my Ph.D. dissertation. Helpful comments and suggestions by Alan Blinder, William Branson, Finn Kydland and by the participants of the June 1980 conference organized by the Society for Economic Dynamics and Control are gratefully acknowledged. Naturally, I retain sole responsibility for any remaining errors.