WP Global Economy 2023.08.14
This is working paper.
In this study, we construct a variant of the Lagos-Wright monetary model in which both buyers and sellers optimally decide whether to enter decentralized mar- ket by paying ﬁxed entry costs. In the decentralized market, the sellers produce the intermediate inputs which are necessary to produce the general good traded in the centralized market. We show that the Friedman rule of setting nominal interest rate to zero may not be optimal. The optimal inﬂation rate is derived explicitly for speciﬁc functional forms. It is shown that the optimal inﬂation rate is lower for lower buyer entry costs, because the lower entry costs generate the congestion of buyers which must be compensated for by lower cost of money holdings. It is also shown that the optimal inﬂation is lower for higher seller entry costs. These results may explain why the secular decline in inﬂation has been observed in recent decades when the emergence and growth of Internet usage has lowered shopping costs for buyers.
Keywords : Optimal monetary policy; entry cost; competitive pricing; low inﬂation.
JEL classiﬁcation code: E13; E42; E52