On the Dynamic Role of Monopolistic Competition in the Monetary Economy
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Abstract
Much static research on the new Keynesian economics is based on the distortion caused by monopolistic pricing. When the theory of monopolistic competition is extended to monetary dynamics in an overlapping generations (OLG) model (Otaki 2007, 2009), the underemployment problem is resolved by a proper monetary policy. However, even in the full-employment equilibrium, the market mechanism does not attain the socially optimal allocation. Since the rate of population growth is assumed to be zero, the optimal gross in- flation rate in the model is unity. There is no such coordination motive in a monetary economy, and hence, the inflation rate may exceed unity. The monopolistic power lowers the inflation rate. The prices of the cur- rent goods relative to the future goods increase by virtue of the monopolistic power. This improves the life- time utility because the lowered inflation rate corrects the consumption stream, which is biased toward the current goods.
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