Abstract
This paper argues that, with a flat Phillips curve, welfare can be improved if the Central Bank stabilizes the output gap directly. The pursuit of price stability may, in fact, increase price stickiness, flatten the Phillips curve further, increase the distortions due to sticky prices, and lead to a welfare loss. This suggests that the Central Bank should be governed by the dual mandate of stabilizing both prices and output, rather than the single mandate of stabilizing only prices. Our argument does not rely on the presence of markup shocks, nor on nominal wage rigidity. Instead, the key to these insights is the consideration of a strategic microfoundation for price stickiness. In this model, the slope of the Phillips curve responds to the intensity of the Central Bank's pursuit of price stability