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Home | Events Archive | Monetary Policy obeying the Taylor Principle Turns Prices into Strategic Substitutes
Seminar

Monetary Policy obeying the Taylor Principle Turns Prices into Strategic Substitutes


  • Series
    Complexity-Macro Seminars
  • Speaker(s)
    Frank Heinemann (TU Berlin, Germany)
  • Field
    Complexity
  • Location
    UvA - E-building, Roetersstraat 11, Room A2.08
    Amsterdam
  • Date and time

    November 09, 2018
    16:00 - 17:15

Monetary policy affects the degree of strategic complementarity in firms’ pricing decisions if it responds to the aggregate price level. In normal times, when monopolistic competitive firms increase their prices, the central bank raises interest rates, which lowers consumption demand and creates an incentive for firms to reduce their prices. Thereby, monetary policy reduces the degree of strategic complementarities among firms’ pricing decisions and even turns prices into strategic substitutes if the effect of interest rates on demand is sufficiently strong. We show that this condition holds when monetary policy follows the Taylor principle. By contrast, in a liquidity trap where monetary policy is restricted by the zero lower bound, pricing decisions are strategic complements. Our main contribution consists in relating the determinacy and stability of equilibria to strategic substitutability in prices. We discuss the consequences for dynamic adjustment processes and some policy implications.