Optimal Monetary Policy in an Imperfect World

We compute the optimal Ramsey policy in a New Keynesian model where the steady state suffers from monopolistic and tax distortions. We show that the optimal monetary policy in this environment displays asymmetric responses to shocks to optimally inflate the economy (slightly) at times when it would be most beneficial to the representative agent to do so. We show that the ergodic mean of inflation under the optimal policy is slightly positive (not zero), that the ergodic mean of the output gap is slightly positive, and that welfare is actually higher than in a flexible-price version of the economy, because of the monetary authority's ability to slightly offset, in ergodic mean, the steady-state distortions in the economy