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Sticky price and limited participation models of money: a comparison

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  • Lawrence J. Christiano
  • Martin Eichenbaum
  • Charles L. Evans

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 conterfactual 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 of factor hoarding, which dampen movements in the marginal cost of production after a monetary policy shock. nerships or affiliated with banking organizations are less likely to provide debt financing than other SBICs.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series, Macroeconomic Issues with number WP-96-28.

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Date of creation: 1996
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Handle: RePEc:fip:fedhma:wp-96-28

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Keywords: Money theory ; Prices;

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References

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  7. V. V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1994. "Inside money, outside money and short-term interest rates," Proceedings, Federal Reserve Bank of Cleveland, pages 1354-1401.
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  9. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
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  13. Lawrence J. Christiano & Martin Eichenbaum, 1993. "Interest rate smoothing in an equilibrium business cycle model," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  14. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
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  29. Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc.
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