Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?

Abstract

We construct a quantitative equilibrium model with firms setting prices in a staggered fashion and use it to ask whether monetary shocks can generate business cycle fluctuations. These fluctuations include persistent movements in output along with the other defining features of business cycles, like volatile investment and smooth consumption. We assume that prices are exogenously sticky for a short time. Persistent output fluctuations require endogenous price stickiness in the sense that firms choose not to change prices much when they can do so. We find that for a wide range of parameter values, the amount of endogenous stickiness is small. Thus, we find that in a standard quantitative model, staggered price-setting, alone, does not generate business cycle fluctuations.

Price-Setting Behaviour in Belgium: What Can Be Learned from an Ad Hoc Survey ?

“…Jeanne (1998), Romer (2001), Eichenbaum and Fisher (2004) are examples of the New-Keynesian literature in which typically the interplay between both types of rigidity is emphasised, while Chari, Kehoe and Mc Grattan (2000) seriously challenge the ability of (empirically realistic) nominal rigidities, as such, to produce sufficient sluggishness at the aggregate level. Second, a question was inserted on the information set the newly decided prices are based on (questions B2a and B2b), as deviations from a fully optimising behaviour can be an additional source of sluggishness in the response of inflation to shocks, for instance as a result of rule of thumb price setters as in Galí et al (2001), as a result of indexation schemes as in Christiano, Eichenbaum and Evans (2001) or Smets and Wouters (2003), or as a result of stickiness in either the information gathering and/or the optimisation processes as in Mankiw and Reiss (2002).…”

Business cycle fluctuations in Brazil

“…In this sense any model consistent with optimum behavior of firms and individuals may be tested through the RBC approach, there is no reason whatsoever to avoid hypotheses that are strange to the new-classical macroeconomics, as long as the hypothesis is consistent with a dynamic general equilibrium (DGE) model. From this perspective the name "real business cycle" may not be the most appropriate to describe the new methodology, for some authors in the field are calibrating and simulating models with interesting nominal properties: recently even papers presenting nominal rigidities have been incorporated into the RBC analysis (see, for example Chari, Kehoe & McGrattan, 2000). The 1 Some references of early business cycle models can be found in Kydland and Prescott (1991).…”

Interest-Rate Rules in a New Keynesian Framework with Investment

“…This phenomenon has been widely investigated in recent papers using optimising models incorporating frictions in price-setting and/or wage-setting, e.g. in Chari et al (2000), Christiano et al (2001) and Giannoni and Woodford (2003).…”

“…The case when capital adjusts relatively fast can be represented by modelling endogenous investment with an economy-wide rental market 77 as in Hairault and Portier (1993), Kimball (1995), Yun (1996), King and Watson (1996), King and Wolman (1996) and Chari et al (2000). A further option consists in introducing a certain degree of inertia in capital accumulation in the model, which, as an additional advantage, seems to match better empirical data on capital stock dynamics.…”