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Sticky prices and volatile output

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  • Martin Ellison
  • Andrew Scott

Abstract

This paper examines the effect of introducing a specific type of price stickiness into a stochastic growth model subject to a cash-in-advance constraint. As in previous studies, it is found that the introduction of price rigidities provides a substantial source of monetary non-neutrality that contributes significantly to output volatility. It is shown that the introduction of this form of sticky prices improves the model's performance at explaining inflation, but worsens it for output. The most dramatic failure of the model is the extremely high-frequency fluctuations in output that it generates. Sticky prices not only fail to produce persistent business cycle fluctuations but they generate volatility at very high frequencies.

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File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2001/wp127.pdf
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Bibliographic Info

Paper provided by Bank of England in its series Bank of England working papers with number 127.

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Date of creation: Apr 2001
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Handle: RePEc:boe:boeewp:127

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