Coordination in Price Setting and the Zero Lower Bound: A Global Games Approach

In this paper, I construct a two-period general equilibrium model and describe price competition among monopolistically competitive firms as a coordination game. While the model has multiple equilibria with different levels of inflation (positive or zero), the equilibrium selection in line with global games implies that the economy with a high natural interest rate, i.e., high expected productivity growth, tends to move into the equilibrium with positive inflation. The policy analyses indicate that monetary policy measures such as an increase in the target inflation rate and a decrease in the lower bound of nominal interest rates can prevent the economy from moving into the zero inflation equilibrium even in the face of low expected productivity growth.