Survey_KW_2004

Abstract

The model economy that we study is a particular fully articulated “New Keynesian” framework, featuring monopolistic competition and nominal prices which are fixed for two periods. There is staggered pricing, with one-half of a continuum of firms adjusting price in each period. Since all of the firms have the same technology and face the same demand conditions, it is natural to think of all adjusting firms as choosing the same price. We impose this symmetry condition in our analysis. There is a representative household, which values consumption (ct) and leisure (lt) according to a standard time separable expected utility objective with ? being the discount factor. Much of our analysis will focus on the implications of efficient price-setting by the monopolistically competitive firm. The adjusting firms in period t are assumed to set prices so as to maximize the expected present discounted value of their revenues, using the household’s marginal utility as a (possibly stochastic) discount factor. In our context, we are interested in complementarity in price-setting in equation (11). The left-hand side of this expression is the action of the particular decision-maker under study: the optimal price of an individual monopolistically competitive firm that is currently making a price adjustment. Other monopolistically competitive firms are also simultaneously adjusting prices: these firms take an action P0,t that influences the right-hand of (11). Given that prices are sticky, there can be real effects of variations in the price level, so that these could influence nominal marginal cost. Finally, the weights on the present and the future in (11) also depend on the price level. To determine whether there is complementarity, we must work through these mechanisms and determine the sign of the relevant partial derivative. The extent of complementarity will depend on the behavior of the monetary authority. The sequence of actions within a period is as follows. In the first stage, the monetary authority chooses the money stock, Mt, taking as given P1,t, the price set by firms in the previous period. In the second stage, adjusting firms set prices (P0,t). Simultaneously,wages are determined and exchange occurs in labor and goods markets.