RAMSEY MONETARY POLICY WITH CAPITAL ACCUMULATION AND NOMINAL RIGIDITIES

Recent literature on the design of optimal monetary policy has shown that deviations fromprice stability are small whenever prices are sticky. This paper reconsiders this issue byintroducing capital accumulation in the model. Optimal monetary policy in this setupimplies small deviations from price stability. The monetary authority optimally usesinflation as an explicit tax on monopolistic profits to reduce the price markup acrossstates. Variable markup is achieved in this setup because the share of investment demandover output varies across states and in response to TFP shocks.[...]