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Gaps and Triangles

Authors 
Isabel Horta Correia
Publication Year 
2001
JEL Code 
E31 - Price Level; Inflation; Deflation
E41 - Demand for Money
E58 - Central Banks and Their Policies
E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation
Abstract 
We derive principles of optimal short run monetary policy in a real business cycles model, with money and with monopolistic firms that set prices one period in advance. The only distortionary policy instruments are the nominal interest rates and the money supplies. In this environment it is feasible to undo both the cash in advance and the price setting restrictions. We show that the optimal allocation is achieved under the Friedman rule. We also show that, in general, it is not optimal to undo the restriction that prices are set one period in advance. Sticky prices provide the planner with tools to improve upon a distorted flexible prices allocation.
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Gaps and Triangles
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