Sticky price and limited participation models of money: A comparison

doi:10.1016/S0014-2921(97)00071-8

European Economic Review

Volume 41, Issue 6, June 1997, Pages 1201-1249

https://doi.org/10.1016/S0014-2921(97)00071-8 Get rights and content

Abstract

We provide new evidence that models of the monetary transmission mechanism should be consistent with at least the following facts. After a contractionary monetary policy shock, the aggregate price level responds very little, aggregate output falls, interest rates initially rise, real wages decline by a modest amount, and profits fall. We compare the ability of sticky price and limited participation models with frictionless labor markets to account for these facts. The key failing of the sticky price model lies in its counterfactual implications for profits. The limited participation model can account for all the above facts, but only if one is willing to assume a high labor supply elasticity (2 percent) and a high markup (40 percent). The shortcomings of both models reflect the absence of labor market frictions, such as wage contracts or factor hoarding, which dampen movements in the marginal cost of production after a monetary policy shock. © 1997 Elsevier Science B.V.

References (36)

L.J. Christiano
Why does inventory investment fluctuate so much?
J. Monetary Econ.
(1988)
T.S. Fuerst
Liquidity, loanable funds, and real activity
J. Monetary Econ.
(1992)
G. Hansen
Indivisible labor and the business cycle
J. Monetary Econ.
(1985)
A. Hornstein
Monopolistic competition, increasing to scale, and the importance of productivity shocks
J. Monetary Econ.
(1993)
M. Killingsworth et al.
Female labor supply: A survey
R.E. Lucas
Expectations and the neutrality of money
J. Econ. Theory
(1972)
R.E. Lucas
Liquidity and interest rates
J. Econ. Theory
(1990)
J. Pencavel
Labor supply of men: A survey
S. Basu
Intermediate goods and business cycles: Implications for productivity and welfare
Am. Econ. Rev.
(1995)
S. Basu et al.
Constant returns and small markups in US manufacturing

J. Benhabib et al.

Homework in macroeconomics: Household production and aggregate fluctuations

J. Political Econ.

(1991)

O.J. Blanchard et al.

Monopolistic competition and the effects of aggregate demand

Am. Econ. Rev.

(1987)

C Burnside et al.

Factor hoarding and the propagation of business cycle shocks

Am. Econ. Rev.

(1996)

D. Card

Intertemporal labor supply: An assessment

National Bureau of Economic, Research Working Paper No. 3602

(1991)

V.V. Chari et al.

Inside money, outside money, and short-term interest rates

J. Money, Credit, and Banking

(1995)

V.V. Chari et al.

Sticky price models of the business cycle: The persistence problem

(1996)

J.O. Cho et al.

The business cycle with nominal contracts

Econ. Theory

(1995)

L.J. Christiano

Linear-quadratic approximation and value-function iteration: A comparison

J. Business and Economic Statistics

(1990)

Cited by (230)

Securitization, shadow banking system and macroprudential regulation: A DSGE approach
2024, Economic Modelling
We investigate the role of macroprudential policy in the presence of traditional banks and shadow intermediaries through the lens of a dynamic, stochastic, general equilibrium (DSGE) model. We examine how the shadow financial system affects macroeconomic activity and financial stability via the transmission channels of the securitization market. In general equilibrium, securitization leads to the emergence of moral hazard and regulatory arbitrage, which are not internalized by the financial system. The model uncovers a tradeoff. On the one hand, shadow intermediaries increase aggregate efficiency by allowing for capital redeployment through the securitization market. On the other hand, they exacerbate externalities underlying financial intermediation. We show that a macroprudential authority aiming at mitigating these externalities via limits to bank leverage and caps to securitization in the traditional banking sector, faces a welfare-volatility tradeoff. The results call for policy measures addressed to the shadow banking sector in order to ensure a more stable financial system.
Graph theoretic approach to expose the energy-induced crisis in Pakistan
2022, Energy Policy
Pakistan is an energy-deficient country and relies heavily on imported fossil fuels despite significant potential for it to instead develop renewable energy resources. This paper employs a newly developed causality determination scheme known as the Graph Theoretic Approach (GTA), which is based on the modified Peter and Clark algorithm. In this study the energy-inflation causal nexus has been investigated using real time-series data covering the past 30 years (1990–2019) based on nine key variables of the economy, i.e., inflation rate, oil prices, interest rate, money supply, GDP, exchange rate, unit value of import, unit value of export and output shortfalls. Results show that causality runs from energy prices and interest rate to inflation, suggesting that energy prices and interest rate are positively associated with inflation. Moreover, both energy prices and monetary policy have cost-side effects on inflation; however, the latter becomes counterproductive whenever a high interest rate is used to curtail energy-push-inflation. It is concluded that, an increased dependence on imported fossil fuels causes energy-push-inflation. Therefore, policymakers need to incorporate much more renewable energy resources in the fuel mix so that heavy energy import bills can be avoided in the long-run, thereby controlling the cost-side channel of inflation.
The cost channel of monetary policy: The case of the United States in the period 1959–2018
2022, Structural Change and Economic Dynamics
In light of the literature on the ‘price puzzle’, this paper shows that a positive effect of a tightening of monetary policy on the level of prices should be considered a normal phenomenon rather than an ‘anomaly’ or a ‘specific regime phenomenon’ connected to passive behaviour of the Central Bank in response to changes in the inflation rate. To assess the effect of monetary policy on the level of prices, we estimate SVAR models based on US monthly data for the period 1959–2018. Alternative measures of price and inflation expectations are also taken into consideration to avoid feasible spurious correlation. Finally, all selected models are estimated along four different sub-samples to consider different monetary policy regimes. Our findings show that the ‘price puzzle’ exists irrespective of both the passive (active) behaviour of the Central Bank and the inclusion of price expectations.
The cost-channel of monetary transmission under positive trend inflation
2021, Economics Letters
We study the dynamics of the cost-channel of monetary transmission mechanism using a New-Keynesian model with nonzero steady state inflation. We show that the effects of the cost-channel depend almost entirely on the level of trend inflation in the economy. These results are demonstrated analytically and numerically by focusing on the impact of monetary policy shocks on the response of inflation and output.
On the welfare and cyclical implications of moderate trend inflation
2018, Journal of Monetary Economics
The welfare and cyclical implications of moderate trend inflation are addressed in an augmented medium-scale DSGE model. Increasing trend inflation from 2 to 4 percent generates a consumption-equivalent welfare loss of about 4 percent. Welfare costs of this magnitude are driven by: staggered wage contracts, trend growth, extended borrowing, a roundabout production structure, and the interaction between trend inflation and shocks to the marginal efficiency of investment (MEI). A sticky-price model abstracting from these features generates much smaller losses. Moderate trend inflation also has important business-cycle implications, interacting much more strongly with MEI shocks than with productivity or monetary shocks.
Inflation, output and markup dynamics with purely forward-looking wage and price setters
2018, European Economic Review
Medium-scale New Keynesian models are sometimes criticized for their use of backward-looking wage and price setting mechanisms, and for assuming several types of disturbances, including some that would be difficult to interpret economically. We propose a DSGE model with purely forward-looking wage and price setters and parsimoniously chosen disturbances. Our model emphasizes an interplay between production firms networking and working capital. Firms can use working capital to finance all (or a fraction) of their outlays on production factors, and use the output of other firms as an input in a what is often called a “roundabout” production structure. Our model generates a response of inflation which is mute on impact of a monetary policy shock, but highly persistent and very hump-shaped afterwards. It also yields a large contract multiplier for output, two times larger than the one implied by a model relying on indexation only. We also show that the response of the price markup can be positive on impact of an expansionary monetary policy shock, which differs from the standard countercyclical markup channel emphasized in conventional New Keynesian models. In contrast to models relying on indexation to past inflation, our model produces non-inertial responses of inflation to productivity and investment shocks, a finding which is broadly consistent with the existing VAR evidence.

View all citing articles on Scopus

View full text

Sticky price and limited participation models of money: A comparison

Abstract

J. Monetary Econ.

J. Monetary Econ.

J. Monetary Econ.

J. Monetary Econ.

J. Econ. Theory

J. Econ. Theory

Intermediate goods and business cycles: Implications for productivity and welfare

Am. Econ. Rev.

Constant returns and small markups in US manufacturing

Homework in macroeconomics: Household production and aggregate fluctuations

J. Political Econ.

Monopolistic competition and the effects of aggregate demand

Am. Econ. Rev.

Factor hoarding and the propagation of business cycle shocks

Am. Econ. Rev.

Intertemporal labor supply: An assessment

National Bureau of Economic, Research Working Paper No. 3602

Inside money, outside money, and short-term interest rates

J. Money, Credit, and Banking

Sticky price models of the business cycle: The persistence problem

The business cycle with nominal contracts

Econ. Theory

Linear-quadratic approximation and value-function iteration: A comparison

J. Business and Economic Statistics