The Bank of Japan is the central bank of Japan.
HOME > Index by Information Type > Research Papers > > Bank of Japan Working Paper Series > Endogenous Nominal Rigidities and Monetary Policy
Endogenous Nominal Rigidities and Monetary Policy
June 2008
Takeshi Kimura*
Takushi Kurozumi**
Naoko Hara***
Click on wp08e04.pdf to download the full text.
Abstract
Recent empirical literature suggests that the degree of nominal rigidities varies over monetary policy regimes. This implies that monetary policy analysis with exogenously given nominal rigidities is subject to the Lucas critique. In a Calvo-style sticky price model, we endogenize nominal rigidities and examine their implications for monetary policy. While some previous studies stress that the frequency of price adjustment changes with a central bank's inflation target, we focus on how this frequency varies in response to changes in policy coefficients of the Taylor rule with a fixed inflation target. We find that a central bank's more aggressive policy response to inflation makes firms less likely to reset their prices. The resulting New Keynesian Phillips curve contains a flatter slope and a smaller variance of disturbances, as observed during the Volcker-Greenspan era. We also find that a central bank's aggressive policy response to inflation can stabilize both inflation and the output gap by exploiting the feedback effects of the bank's policy response on firms' price setting. This supports the good policy hypothesis about the Great Moderation. Finally, we show that changes in the policy coefficients dramatically affect the inflation weight of the social welfare loss function, since this weight increases nonlinearly with the frequency of no price adjustment. To reduce social welfare loss, it is crucial for central banks to take into account that the inflation weight changes endogenously with their policy stances.
JEL classification: E31; E32; E52
Keywords: Monetary policy; Endogenous nominal rigidities; Great Moderation
The authors appreciate discussions and comments from Kosuke Aoki, Shin-ichi Fukuda, Hibiki Ichiue, Eiji Maeda, Bennett McCallum, Kazuo Momma, Toshihiko Mukoyama, Tomoyuki Nakajima, Mototsugu Shintani, Etsuro Shioji, Toyoichiro Shirota, Willem Van Zandweghe, Tsutomu Watanabe, and seminar participants at the University of Tokyo and the Bank of Japan. Any remaining errors are the sole responsibility of the authors. The views expressed herein are those of the authors and should not be interpreted as those of the Bank of Japan.
| * | Financial Markets Department, Bank of Japan takeshi.kimura@boj.or.jp |
| ** | Research and Statistics Department, Bank of Japan takushi.kurozumi@boj.or.jp |
| *** | Research and Statistics Department, Bank of Japan naoko.hara@boj.or.jp |
Papers in the Bank of Japan Working Paper Series are circulated in order to stimulate discussion and comments. Views expressed are those of authors and do not necessarily reflect those of the Bank.
If you have any comment or question on the working paper series, please contact each author.
When making a copy or reproduction of the content for commercial purposes, please contact the Public Relations Department (webmaster@info.boj.or.jp) at the Bank in advance to request permission. When making a copy or reproduction, the source, Bank of Japan Working Paper Series, should explicitly be credited.
Related theme
