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Predicting the effects of Federal Reserve policy in a sticky price model: an analytical approach

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Ellen McGrattan

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Abstract

In this paper, I characterize equilibria for a sticky-price model in which Federal Reserve policy is an interest-rate rule similar to that described in Taylor (1993). For standard preferences and technologies used in the literature, the model predicts that the nominal interest rate is negatively serially correlated, and that shocks to interest rates imply a potentially large but short-lived response in output. Shocks to government spending and technology lead to persistent changes in output but the percentage change in output is predicted to be smaller than the percentage changes in spending or technology. I compare the model's predictions to data using innovations backed out from estimated processes for interest rates, government spending, and technology shocks. These comparisons confirm the theoretical findings. In response to observed changes in government spending and technology, the model predicts a path for output that is much smoother than the data and much smoother than that predicted by non-sticky price models.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2001)
Issue (Month): Jun ()
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Handle: RePEc:fip:fedfpr:y:2001:i:jun:x:4

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Keywords: Monetary policy ; Prices;

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References listed on IDEAS
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Schabert, Andreas, 2001. "Interest Rate Policy and the Price Puzzle in a Quantitative Business Cycle Model," Economics Series 95, Institute for Advanced Studies. [Downloadable!]
  2. Michael Dotsey, 2002. "Structure from shocks," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 37-47. [Downloadable!]
  3. Sustek, Roman, 2009. "Monetary Business Cycle Accounting," MPRA Paper 17518, University Library of Munich, Germany. [Downloadable!]
  4. Burkhard Heer & Andreas Schabert, 2000. "Open Market Operations as a Monetary Policy Shock Measure in a Quantitative Business Cycle Model," Econometric Society World Congress 2000 Contributed Papers 1040, Econometric Society. [Downloadable!]
    Other versions:
  5. Jordi Galí & David López-Salido & Javier Vallés, 2000. "Technology Shocks and Monetary policy: Assessing the Fed's Performance," Banco de España Working Papers 0013, Banco de España. [Downloadable!]
    Other versions:
  6. Pedro Amaral & James C. MacGee, 2002. "The Great Depression in Canada and the United States: A Neoclassical Perspective," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(1), pages 45-72, January. [Downloadable!] (restricted)
    Other versions:
  7. Ellen R. McGrattan, 2004. "Comment on Gali and Rabanal's "Technology shocks and aggregate fluctuations: how well does the RBC model fit postwar U.S. data?"," Staff Report 338, Federal Reserve Bank of Minneapolis. [Downloadable!]
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