Second-order approximation to the Rotemberg model around a distorted steady state

Social welfare objectives are investigated when changing prices is costly (Rotemberg, 1982). A quadratic welfare function is derived, with a distorted steady state, implying inflation and output stabilization goals. Economic distortions influence inflation aversion in a way that differs from Calvo models.

Research Highlights► Less is known about social welfare objectives when it is costly to change prices. ► A quadratic welfare function is derived for distorted steady state under costly price adjustment. ► We highlight the similarities and differences to the Calvo setup. ► Both models imply inflation and output stabilization goals. ► Distortions affect inflation aversion in a way with no counterpart in Calvo.