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Working Paper Series

The Case for Price Stability

WP 01-02

Marvin Goodfriend
Federal Reserve Bank of Richmond
Robert G. King
Boston University

This paper can be downloaded without charge from:
http://www.richmondfed.org/publications/

The Case for Price Stability
Marvin Goodfriend

Robert G. King¤

Federal Reserve Bank of Richmond Working Paper No. 01-02
April 2001
JEL Nos. E3, E5, E6
Keywords: in‡ation persistence, markup constancy, neutral monetary policy, new neoclassical
synthesis, optimal monetary and …scal policy, price level stability, real business cycles, sticky
wages and prices

Abstract
Reasoning within the New Neoclassical Synthesis (NNS) we previously recommended that price stability should be the primary objective of monetary policy. We
called this a neutral policy because it keeps output at its potential, de…ned as the outcome of an imperfectly competitive real business cycle model with a constant markup
of price over marginal cost. We explore the foundations of neutral policy more fully
in this paper. Using the principles of public …nance, we derive conditions under which
markup constancy is optimal monetary policy.
Price stability as the primary policy objective has been criticized on a number of
grounds which we evaluate in this paper. We show that observed in‡ation persistence
in U.S. time series is consistent with the absence of structural in‡ation stickiness as is
the case in the benchmark NNS economy. We consider reasons why monetary policy
might depart from markup constancy and price stability, but we argue that optimal
departures are likely to be minor. Finally, we argue that the presence of nominal wage
stickiness in labor markets does not undermine the case for neutral policy and price
stability.

¤

Goodfriend is Senior Vice President and Policy Advisor at the Federal Reserve Bank of Richmond. King
is Professor of Economics at Boston University, an NBER research associate, and a consultant to the FRB
Richmond. The paper was prepared for the First ECB Central Banking Conference, Why Price Stability?,
Frankfurt, Germany, November 2000. We thank our discussants Jordi Gali and Guido Tabellini for valuable
comments. Our opinions do not necessarily represent those of the Federal Reserve Bank of Richmond or
the Federal Reserve System.

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10

8

6

4

2

0
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1965

1970

1975

1980

1985

1990

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Full text of Working Papers (Federal Reserve Bank of Richmond) : The Case for Price Stability, Working Paper 01-02

FRASER
