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Economic Quarterly

Summer 2008

Nominal Frictions, Relative Price Adjustment, and the Limits to Monetary Policy

Alexander L. Wolman

In simple sticky-price models, the guiding principle for optimal monetary policy is to stabilize nominal prices so as to eliminate the distortions associated with price adjustment. If there is only one sector, or one category of consumption goods, then stabilizing nominal prices means making the inflation rate zero. A growing subliterature on sticky prices considers optimal monetary policy when there are multiple sectors of sticky-price goods, broadly defined. If the relative prices of these goods need to move over time, then the principle just stated cannot be satisfied for all goods. Here I sketch some theoretical models to clarify the issues involved and use data for the United States to suggest that these issues are not mere theoretical curiosities.

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