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Explaining hump-shaped inflation responses to monetary policy shocks

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  • James Yetman

    (University of Hong Kong, Hong Kong)

Abstract

According to conventional wisdom, the output effects of a monetary policy shock commence within months of the shock, while most inflationary effects lag significantly. We demonstrate a simple model that can explain the conventional wisdom and is consistent with profit maximizing price setting decisions by firms, based on the assumption that renegotiating existing contracts is costly. Thus, firms jointly choose both their price and the expected length of time for which that price will hold each time they re-contract. We show that such a 'sticky contracting' assumption, combined with menu costs, generates a hump-shaped inflation response to monetary policy shocks. Copyright © 2007 John Wiley & Sons, Ltd.

Suggested Citation

  • James Yetman, 2007. "Explaining hump-shaped inflation responses to monetary policy shocks," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(6), pages 605-617.
    • Handle: RePEc:wly:mgtdec:v:28:y:2007:i:6:p:605-617
    DOI: 10.1002/mde.1326
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    References listed on IDEAS

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    1. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing and the General Equilibrium Dynamics of Money and Output," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(2), pages 655-690.
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    5. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(4), pages 1295-1328.
    6. Rotemberg, Julio J., 2005. "Customer anger at price increases, changes in the frequency of price adjustment and monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 829-852, May.
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    1. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(4), pages 1295-1328.
    2. Mohamed Safouane Ben Aïssa & Olivier Musy, 2011. "The Dynamic Properties Of Alternative Assumptions On Price Adjustment In New Keynesian Models," Bulletin of Economic Research, Wiley Blackwell, vol. 63(4), pages 353-384, October.
    3. Daniel Levy, 2007. "Price rigidity and flexibility: recent theoretical developments," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(6), pages 523-530.

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