Endogenous markups in the new Keynesian model: Implications for inflation–output trade-off and welfare

This paper extends the standard new Keynesian (NK) model by using the endogenous markup setting a la Kimball (1995). In this setting, consumers' price elasticity of demand for a good is increasing in the good's relative price level, which affects the desired price markup of firms. In the l...

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Bibliographic Details
Published in:Economic modelling 2015-12, Vol.51, p.626-634
Main Author: Eksi, Ozan
Format: Article
Language:English
Subjects:
Elasticity of demand
Endogenous markups
Inflation–output trade-off
Keynesian theory
Monetary policy
Price elasticity
Price levels
Studies
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Summary:This paper extends the standard new Keynesian (NK) model by using the endogenous markup setting a la Kimball (1995). In this setting, consumers' price elasticity of demand for a good is increasing in the good's relative price level, which affects the desired price markup of firms. In the literature, this setting is mainly used to improve the NK models in matching sluggishness of prices in the data. Our paper analyzes the monetary policy implications of the model. It is shown that unlike the cases of real wage rigidity and exogenous markup shocks, the endogenous markup setting does not improve the NK models in generating the inflation–output trade-off. It is also discussed that the optimal monetary policy in this environment is to target the flexible price equilibrium. •We extend the standard new Keynesian model with the endogenous markup setting.•We allow for both supply and preference shocks in the model.•The model does not generate the inflation–output policy trade-off.•The optimal monetary policy is to target the flexible price equilibrium.
ISSN:0264-9993
1873-6122
DOI:10.1016/j.econmod.2015.09.005