Uncertainty shocks, precautionary pricing, and optimal monetary policy
Uncertainty shocks, precautionary pricing, and optimal monetary policy
Existing studies show that, in standard New Keynesian models, uncertainty shocks manifest as cost-push shocks due to the precautionary pricing channel. We study optimal monetary policy in response to uncertainty shocks when the precautionary pricing channel is operative. We show that, in the absence of real imperfections, the optimal monetary policy fully stabilizes the output gap and inflation, implying no policy trade-offs. Our result suggests that precautionary pricing matters only insofar as expected inflation is volatile. Thus, a simple Taylor rule that places high weight on inflation leads to a stabilized output gap, thereby attaining the “divine coincidence”.
Cho, Daeha
3acdf7bf-1ccd-4a2e-8327-f208e350f22f
Han, Yoonshin
727222b7-d59e-4122-9271-7bc0036a1bda
Oh, Joonseok
020d4770-4b18-4b76-bf81-d3e58b9f4eed
Rogantini Picco, Anna
e692e8b2-9e13-4ad1-8deb-ff557346a68c
24 July 2021
Cho, Daeha
3acdf7bf-1ccd-4a2e-8327-f208e350f22f
Han, Yoonshin
727222b7-d59e-4122-9271-7bc0036a1bda
Oh, Joonseok
020d4770-4b18-4b76-bf81-d3e58b9f4eed
Rogantini Picco, Anna
e692e8b2-9e13-4ad1-8deb-ff557346a68c
Cho, Daeha, Han, Yoonshin, Oh, Joonseok and Rogantini Picco, Anna
(2021)
Uncertainty shocks, precautionary pricing, and optimal monetary policy.
Journal of Macroeconomics, 69, [103343].
(doi:10.1016/j.jmacro.2021.103343).
Abstract
Existing studies show that, in standard New Keynesian models, uncertainty shocks manifest as cost-push shocks due to the precautionary pricing channel. We study optimal monetary policy in response to uncertainty shocks when the precautionary pricing channel is operative. We show that, in the absence of real imperfections, the optimal monetary policy fully stabilizes the output gap and inflation, implying no policy trade-offs. Our result suggests that precautionary pricing matters only insofar as expected inflation is volatile. Thus, a simple Taylor rule that places high weight on inflation leads to a stabilized output gap, thereby attaining the “divine coincidence”.
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Accepted/In Press date: 28 June 2021
e-pub ahead of print date: 15 July 2021
Published date: 24 July 2021
Identifiers
Local EPrints ID: 484883
URI: http://eprints.soton.ac.uk/id/eprint/484883
ISSN: 0164-0704
PURE UUID: fdf571aa-0bbf-4dfa-811b-335c5e74ef77
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Date deposited: 23 Nov 2023 18:28
Last modified: 18 Mar 2024 05:02
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Contributors
Author:
Daeha Cho
Author:
Yoonshin Han
Author:
Joonseok Oh
Author:
Anna Rogantini Picco
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