Publication

This paper states that strategic complementarities – such as firm-specific factors or quasi-kinked demand – have crucial implications for the design of monetary policy and for the welfare costs of output and inflation variability. The authors explicitly consider the nonlinear properties of these mechanisms that are relevant for characterizing the deterministic steady state as well as the second-order approximation of social welfare in the stochastic economy. They demonstrate that firm-specific factors and quasi-kinked demand curves yield markedly different implications for the welfare costs of steady-state inflation and inflation volatility, and they show that these considerations have dramatic consequences in assessing the relative price distortions associated with the Great Inflation of 1965-1979.