Coordination in price setting and the zero lower bound: a global games approach

Abstract

AbstractThis paper constructs a two-period general equilibrium model with the effective lower bound of nominal interest rates and describes price competition among monopolistically competitive firms as a coordination game. While the model has multiple equilibria with different levels of inflation (positive or zero), the equilibrium selection in line with global games implies that the economy with high expected productivity growth moves into the positive inflation equilibrium. The policy analyses indicate that monetary policy measures such as an increase in the target inflation can prevent the economy from moving into the zero inflation equilibrium even with low productivity growth.