Information Frictions, Monetary Policy, and the Paradox of Price Flexibility

50 Pages Posted: 1 Dec 2020

See all articles by Shengliang Ou

Shengliang Ou

Shanghai University of Finance and Economics

Donghai Zhang

Institute for Macroeconomics and Econometrics - University of Bonn

Renbin Zhang

Shandong University

Date Written: October 23, 2020

Abstract

The introduction of digital price tags and online shopping may facilitate price adjustments and reduce the degree of nominal rigidity in the economy. Is this welfare-improving? We address this question in a multi-sector New Keynesian model with information frictions and dispersed beliefs. Increased price flexibility may deteriorate welfare through the dispersed beliefs channel and the amplified spillover effects. The dispersed beliefs create a novel channel through which the welfare cost of inflation in a sector increases in price flexibility, altering the optimal inflation target policy. A monetary policy that stabilizes the optimal inflation index mitigates the paradox.

Keywords: Dispersed beliefs, Information Frictions, Spillover Effects, Monetary Policy, Inflation Target, Paradox of Price Flexibility

JEL Classification: E31, E32, E52, E58

Suggested Citation

Ou, Shengliang and Zhang, Donghai and Zhang, Renbin, Information Frictions, Monetary Policy, and the Paradox of Price Flexibility (October 23, 2020). Available at SSRN: https://ssrn.com/abstract=3717453 or http://dx.doi.org/10.2139/ssrn.3717453

Shengliang Ou

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Donghai Zhang (Contact Author)

Institute for Macroeconomics and Econometrics - University of Bonn ( email )

Bonn
Germany

Renbin Zhang

Shandong University ( email )

shanda nanlu 27
jinan, Shandong 250100
China

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