Abstract
Much static research on the new Keynesian economics is based on the distortion caused by monopolistic pricing. When the theory of monopolistic competition is extended to monetary dynamics in an overlapping generations (OLG) model (Otaki 2007, 2009), the underemployment problem is resolved by a proper monetary policy. However, even in the full-employment equilibrium, the market mechanism does not attain the socially optimal allocation. Since the rate of population growth is assumed to be zero, the optimal gross in- flation rate in the model is unity. There is no such coordination motive in a monetary economy, and hence, the inflation rate may exceed unity. The monopolistic power lowers the inflation rate. The prices of the cur- rent goods relative to the future goods increase by virtue of the monopolistic power. This improves the life- time utility because the lowered inflation rate corrects the consumption stream, which is biased toward the current goods.
Highlights
It is well known that monopolistic competition plays an important role in the new Keynesian economics.1 The price of goods relative to that of leisure becomes too high, resulting in a shortage of consumption and an excess of leisure
Inflation, which makes the Walrasian equilibrium dynamically inefficient, is a true social cost incurred from using money, and the monopolistic competition can contribute to the economic welfare through a reduction in such cost
This paper investigated the dynamic role of the monopolistic competition in the monetary economy
Summary
It is well known that monopolistic competition plays an important role in the new Keynesian economics. The price of goods relative to that of leisure becomes too high, resulting in a shortage of consumption and an excess of leisure. When we extend the theory to monetary economic dynamics in the OLG model (Otaki [1,2]), we see that a proper monetary policy can resolve the underemployment problem. When the population growth is zero, the optimal gross inflation rate is unity. The reason for this is that the quantity of goods transferred to old individuals is the. Same as that given by them to the previous generation Since such coordination is impossible in the monetary economy, where decision making is separated generation by generation, the equilibrium gross inflation rate possibly exceeds unity.
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