Survey_Adam_2003

Abstract

Presented is a simple model with imperfectly competitive firms, flexible prices, and a policy maker using nominal demand to minimize the quadratic deviations of output and prices from target. The novel feature of the model is that firms (an potentially also the policy maker) possess private information about the shocks hitting the economy and that for such a setting optimal nominal demand policy is determined. In the present model prices display inefficient dispersion because firms’ information sets contain some amount of private information. This differs from New Keynesian models where price dispersion is instead due to nominal price stickiness in combination with time varying profit-maximizing prices. To assume that consumers adapt the consumption of different varieties to information-induced price dispersion would amount to assuming that consumers know about firms’ private information. This seems highly unlikely. Moreover, price stability is the standard objective of modern central banks. Therefore, at least from a central banker’s perspective, objective functions should contain a price level target. It is acknowledged, however, that the price level target does not capture welfare implications that can be deduced directly from the model.