Dynamics of Sticky Information and Sticky Price Models in a New Keynesian DSGE Framework

Arslan, Mesut Murat (2007): Dynamics of Sticky Information and Sticky Price Models in a New Keynesian DSGE Framework. Unpublished.

Abstract

Recent literature on monetary policy analysis extensively uses the sticky price model of price adjustment in a New Keynesian Macroeconomic framework. This price setting model, however, has been criticized for producing implausible results regarding inflation and output dynamics. This paper examines and compares dynamic responses of the sticky price and sticky information models to a cost-push shock in a New Keynesian DSGE framework. It finds that the sticky information model produces more reasonable dynamics through lagged, gradual and hump-shaped responses to a shock as observed in data. However, these responses depend on the persistence of the shock.

• Item Type: MPRA Paper
• Institution: Middle East Technical University (METU)
• Language: English
• Keywords: Monetary policy; Sticky information; Sticky prices; Phillips curve
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy (Targets, Instruments, and Effects); E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E50 - General

References

Arslan, M.M., 2005. Monetary Policy with Sticky Information Phillips Curve under Demand and Policy Shocks. University of Houston, Working Paper.

Ball, L., 1994. Credible Disinflation with Staggered Price Setting. American Economic Review 84, 282-289.

Ball, L., Mankiw, N.G., Reis, R., 2004. Monetary Policy for Inattentive Economies. Journal of Monetary Economics 52, 703-725.

Beaudry, P., Wincoop, E., 1996. The Intertemporal Elasticity of Substitution: An Exploration Using a US Panel of State Data. Economica 63, 495-512.

Benassy, J., 1995. Money and Wage Contracts in an Optimizing Model of the Business Cycle. Journal of Monetary Economics 35, 303-315.

Blanchard, O.J., Kiyotaki, N., 1987. Monopolistic Competition and the Efects of Aggregate Demand. American Economic Review 77, 647-666.

Bils, M., Klenow, P., 2002. Some Evidence on the Importance of Sticky Prices. NBER Working Paper 9069.

Blinder, A.S., Canetti, E.R., Lebow, D., Rudd, J.B., 1998. Asking About Prices: A New Approach to Understand Price Stickiness. Russell Sage Foundation, New York.

Calvo, G., 1983. Staggered Prices in a Utility Maximizing Framework. Journal of Monetary Economics 12, 383-398.

Campbell, J.Y., Mankiw, G., 1989. Consumption, Income, and Interest Rates: Reinter preting the Time Series Evidence. In: Blanchard, O., Fischer, S. (Eds), NBER Macroeconomics Annual.

Chari, V.V., Kehoe, P.J., McGrattan, E.R., 2000. Stikcy Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem? Econometrica 68, 1151-1179.

Clarida, R., Gali, J., Gertler, M., 1999. The Science of Monetary Policy: A New Keynesian Perspective. Journal of Economic Literature 37, 1661-1707.

Clarida, R., Gali, J., Gertler, M., 2001. Optimal Monetary Policy in Open versus Closed Economies: An Integrated Approach. American Economic Review 91, 253-257.

Clarida, R., Gali, J., Gertler, M., 2002. A Simple Framework for International Monetary Policy Analysis. NBER Working Paper 8870.

Cooley, T.F., Hansen, G.D., 1995. Money and the Business Cycle. In: Cooley, T.F. (Eds) Frontiers of Business Cycle Research. Princeton University, Princeton.

Cooley, T.F., Prescott, E.C., 1995. Economic Growth and Business Cycles. In: Cooley, T.F. (Eds) Frontiers of Business Cycle Research. Princeton University, Princeton.

Dixit, A.K., Stiglitz, J.E., 1977. Monopolistic Competition and Optimum Product Diversity. American Economic Review 67, 297-308.

Estrella, A., Fuhrer, J.C., 1998. Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational Expectations Models. Federal Reserve Bank of Boston, Working paper.

Fuhrer, J.C., Moore, G., 1995. Inflation Persistence. Quarterly Journal of Economics 110, 127-159.

Gali, J., Gertler, M., 1999. Inflation Dynamics: A Structural Econometric Analysis. Journal of Monetary Economics 44, 195-222. 33

Goodfriend, M., King, R.G., 1997. The New Neoclassical Synthesis and the Role of Monetary Policy. NBER Macroeconomics Annual.

Hall, R.E., 1988. Intertemporal Substitution in Consumption. Journal of Political Economy 96, 339-357.

Hansen, L.P., Singleton, K.J., 1982. Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models. Econometrica 50, 1269-1286.

Hansen, L.P., Singleton, K.J., 1983. Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns. Journal of Political Economy 91, 249-265.

Hansen, L.P., Singleton, K.J., 1996. E±cient Estimation of Linear Asset Pricing Models with Moving Average Errors. Journal of Business and Economic Statistics 14, 53-68.

Keen, B.D., 2006. Sticky Price and Sticky Information Price Setting Models: What is the Difference? University of Oklahoma, Working Paper.

King, R.G., Watson, M.W., 1996. Money, Prices, Interest Rates and the Business Cycle. Review of Economics and Statistics 78, 35-53.

Lown,C.S., Rich, W.R., 1997. Is There An In°ation Puzzle. Federal Reserve Bank of New York Quarterly Review, 51-69.

Mankiw, N.G., Reis, R., 2002. Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve. Quarterly Journal of Economics 117, 1295-1328.

McCallum, B.T., Nelson, E., 1999a. An Optimizing IS-LM Specification for Monetary Policy and Business Cycle Analysis. Journal of Money, Credit and Banking 31, 296-316.

McCallum, B.T., Nelson, E., 1999b. Performance of Operational Policy Rules in an Estimated Semi classical Structural Model. In: Taylor, J.B. (Eds), Monetary Policy Rules. University of Chicago, Chicago.

McCallum, B.T., Nelson, E., 2000. Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices. Oxford Review of Economic Policy 16, 74-91.

Roberts, J.M., 1997. Is In°ation Sticky? Journal of Monetary Economics 39, 173-196.

Roberts, J.M., 1998. In°ation Expectations and the Transmission of Monetary Policy. Federal Reserve Board, Working paper.

Rotemberg, J., 1987. The New Keynesian Microfoundations. NBER Macroeconomics Annual.

Rotemberg, J., Woodford, M., 1995. Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets. In: Cooley, T.F. (Eds) Frontiers of Business Cycle Research. Princeton University, Princeton.

Rotemberg, J., Woodford, M., 1997. An Optimization Based Econometric Framework for the Evaluation of Monetary Policy. NBER Macroeconomics Annual

Sbordone, A., 2002. Prices and Unit Labor Costs: A New Test of Price Stickiness. Journal of Monetary Economics 49, 265-292.

Svensson, L.E., Woodford, M., 2003. Implementing Optimal Policy through Inflation-Forecast Targeting. In: B. S. Bernanke and M. Woodford (Eds), Inflation Targeting. University of Chicago, Chicago.

Taylor, J.B., 1993. Discretion versus Policy Rules in Practice. Carnegie-Rochester Conference Series on Public Policy 39, 195-214. 34

Taylor, J.B., 1999. Staggered Price and Wage Setting in Macroeconomics. In: Taylor, J.B., Woodford, M. (Eds), Handbook of Macroeconomics, 1009-1050.

Trabandt, M., 2006. Sticky Information vs. Sticky Prices: A Horse Race in a DSGE Framework. Humboldt University, Working Paper.

Yun, T., 1996. Nominal Price Rigidity, Money Supply Endogeneity, and Business Cycles. Journal of Monetary Economics, 345-70.

Woodford, M., 1999. Optimal Monetary Policy Inertia. NBER Working Paper. 7261.

Woodford, M., 2003. Interest and Prices. Princeton University Press, Princeton, NJ. 35