Reset price inflation and the impact of monetary policy shocks (original) (raw)

Price-Setting Behavior and Inflation Dynamics

2003

The Calvo (1983) price-setting assumption underlying the New Keynesian Phillips Curve (NKPC) enables much tractability, but implies that some firms may never adjust their price to shocks. In this paper we make the assumption that price-setting behaviour is identical to Calvo except that all firms adjust their prices after a finite period (the 'truncated-Calvo' model). We characterize inflation dynamics of this economy and examine the consequences of estimating the NKPC and the hybrid-NKPC using simulated data. Our results indicate (i) a model where all firms adjust their prices after 12 quarters is empirically indistinguishable from the NKPC; (ii) when all firms adjust prices within 3 to 5 quarters we find evidence for a significant role of lagged inflation, as in Dotsey . However, the support for the hybrid specification itself is mixed. Our findings suggest that forward-looking models that generate lagged inflation dynamics might be empirically relevant.

Implications of state-dependent pricing for dynamic macroeconomic models

Journal of Monetary Economics, 2005

State-dependent pricing (SDP) models treat the timing of price changes as a profit-maximizing choice, symmetrically with other decisions of firms. Using quantitative general equilibrium models that incorporate a "generalized (S,s) approach," we investigate the implications of SDP for topics in two major areas of macroeconomic research: the early 1990s SDP literature and more recent work on persistence mechanisms. First, we show that state-dependent pricing leads to unusual macroeconomic dynamics, which occur because of the timing of price adjustments chosen by firms as in the earlier literature. In particular, we display an example in which output responses peak at about a year, while inflation responses peak at about two years after the shock. Second, we examine whether the persistence-enhancing effects of two New Keynesian model features, namely, specific factor markets and variable elasticity demand curves, depend importantly on whether pricing is state dependent. In an SDP setting, we provide examples in which specific factor markets perversely work to lower persistence, while variable elasticity demand raises it. *We thank our discussant Susanto Basu for his substantial patience as well as his useful comments and questions. We have also benefited from valuable comments by Alex Wolman and Pierre Sarte. The views expressed in this article are those of the authors and do not necessarily represent those of the Federal Reserve Bank of Philadelphia, the Federal Reserve Bank of Richmond, or the Federal Reserve System.

Monetary Policy, Inflation Expectations and The Price Puzzle*

The Economic Journal, 2010

This article re-examines the VAR evidence on the price puzzle and proposes a new theoretical interpretation. Using actual data and two identification strategies based on zero restrictions and model-consistent sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the sub-samples that are typically associated with a weak interest rate response to inflation. Using pseudo data generated by a sticky price model of the US economy, we then show that the structural VARs are capable of reproducing the price puzzle only when monetary policy is passive. The omission in the VARs of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data. * This article is a revised version of the Bank of England Working Paper No. 266-2006 entitled ÔPrice Puzzle: Fact or Artefact?Õ. We thank Andrew Scott and two anonymous referees for useful comments and suggestions. We are also grateful to

The Macroeconomics of Low Inflation

Brookings Papers on Economic Activity, 1996

THE CONCEPT of a natural unemployment rate has been central to most modern models of inflation and stabilization. According to these models, inflation will accelerate or decelerate depending on whether unemployment is below or above the natural rate, while any existing rate of inflation will continue if unemployment is at the natural rate. The natural rate is thus the minimum, and only, sustainable rate of unemployment, but the inflation rate is left as a choice variable for policymakers. Since complete price stability has attractive features, many economists and policymakers who accept the natural rate hypothesis believe that central banks should target zero inflation. We question the standard version of the natural rate model and each of these implications. Central to our analysis is the effect of downward nominal wage rigidity in an economy in which individual firms experience stochastic shocks in the demand for their output. We embed these features in a model that otherwise resembles a standard natural rate model and show there is no unique natural unemployment rate. Rather, the rate of unemployment that is consistent with steady inflation We would especially like to thank Neil Siegel, Justin Smith, and Jennifer Eichberger for invaluable research assistance. We are also grateful to Pierre Fortin, Harry Holzer, and Christina Romer for providing us with data, and to

Inflation and Real Activity with Firm-Level Productivity Shocks

SSRN Electronic Journal, 2000

Recent measurements of the extent of price stickiness indicate that prices remain fixed for a significant period of time, but that there is also a substantial amount of relative price variability. Extending our prior state-dependent pricing model to a setting in which there are discrete "micro states" interpreted as stochastic productivity variations at the firm level, we study the model's ability to match the micro evidence on price setting as well as its ability to generate persistent real responses to a money supply shock. We find that the model is rich enough so that its steady state can be calibrated to match the distribution of price changes reported in Klenow and Kryvtsov (2008).

Inflation dynamics: A structural econometric analysis

Journal of Monetary Economics, 1999

We develop and estimate a structural model of inflation that allows for a fraction of firms that use a backward looking rule to set prices. The model nests the purely forward looking New Keynesian Phillips curve as a particular case. We use measures of arginal cost as the relevant determinant of inflation, as the theory suggests, instead of an ad-hoc output gap. Real marginal costs are a significant and quantitatively important determinant of inflation. Backward looking price setting, while statistically significant, is not quantitatively important. Thus, we conclude that the New Keynesian Phillips curve provides a good first approximation to the dynamics of inflation.

Stuck at zero: Price rigidity in a runaway inflation

2021

We use micro level retail price data from convenience stores to study the link between 0-ending price points and price rigidity during a period of a runaway inflation, when the annual inflation rate was in the range of 60%–430%. Surprisingly, we find that 0-ending prices are less likely to adjust, and when they do adjust, the average adjustments are larger. These findings suggest that price adjustment barriers associated with round prices are strong enough to cause a systematic delay in price adjustments even in a period of a runaway inflation, when 85 percent of the prices change every month.

Price Adjustment: Inflation Targeting or Price-Level Targeting?∗

2006

I investigate optimal monetary policy in the sticky information model of price ad-justment within a New Keynesian macroeconomic framework. The model is solved for optimal policy, and welfare implications of three alternative monetary policy regimes: unconstrained policy, price-level targeting and inflation targeting, are compared when there is a shock to the economy. The results for a cost-push shock illustrate that optimal policy depends on the degree of price stickiness and the persistence of the shock. Infla-tion targeting is the optimal policy if prices are flexible enough or the shock is persistent enough. However, for a demand shock, inflation targeting emerges as the best policy for all values of the price stickiness and the shock’s persistence. When the volatility of nomi-nal interest rate is taken into consideration, the results indicate that inflation targeting is the best policy, in the sense that it results in smaller welfare loss and volatility of nominal interest rate,...