Price Stability as Optimal Policy: Costly Nominal Adjustment in General
Equilibrium.
by
Max Gillman.
April 1996
Department of Economics. University of Melbourne. Parkville Victoria
3052 Australia
ABSTRACT
This paper juxtaposes the policy trend towards price stability with
the theoretical optimal quantity of money. After reviewing alternatives
to the Friedman (1969) optimum, it focuses on the effect of costly nominal
adjustment as a result of inflation. In a Baumolian (1952) cash-in-advance
economy, the paper finds price stability optimal given that the parameter
for the adjustment cost exceeds a critical value. It then calibrates the
parameter from a case study and finds it significantly exceeds the critical
value. The optimality of price stability holds under alternative adjustment
cost specifications and calibrations.
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