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Sticky-price models and the natural rate hypothesis

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  • Javier Andres
  • J. David López-Salido
  • Edward Nelson

Abstract

A major criticism of standard specifications of price adjustment in models for monetary policy analysis is that they violate the natural rate hypothesis by allowing output to differ from potential in steady state. In this paper we estimate a dynamic optimizing business cycle model whose price-setting behavior satisfies the natural rate hypothesis. The price-adjustment specifications we consider are the sticky-information specification of Mankiw and Reis (2002) and the indexed contracts of Christiano, Eichenbaum, and Evans (2005). Our empirical estimates of the real side of the economy are similar whichever price adjustment specification is chosen. Consequently, the alternative model specifications deliver similar estimates of the U.S. output gap series, but the empirical behavior of the gap series differs substantially from standard gap estimates.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2005-018.

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Date of creation: 2005
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Publication status: Published in Journal of Monetary Economics, July 2005, 52(5), pp. 1025-53
Handle: RePEc:fip:fedlwp:2005-018

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Keywords: Monetary policy ; Prices;

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  1. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," NBER Working Papers 11034, National Bureau of Economic Research, Inc.
  2. Martin Eichenbaum & Jonas D.M. Fisher, 2003. "Evaluating the Calvo model of sticky prices," Working Paper Series WP-03-23, Federal Reserve Bank of Chicago.
  3. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
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  7. Peter N. Ireland, 2001. "Endogenous Money or Sticky Prices?," Boston College Working Papers in Economics 499, Boston College Department of Economics.
  8. Mankiw, N. Gregory & Reis, Ricardo, 2002. "Sticky Information Versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," Scholarly Articles 3415324, Harvard University Department of Economics.
  9. Bennett T. McCallum, 1995. "A Semi-Classical Model of Price Level Adjustment," NBER Working Papers 4706, National Bureau of Economic Research, Inc.
  10. Jordi Gali & Mark Gertler & J. David Lopez-Salido, 2001. "European Inflation Dynamics," NBER Working Papers 8218, National Bureau of Economic Research, Inc.
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  12. Katharine S. Neiss and Edward Nelson, 2001. "The Real Interest Rate Gap as an Inflation Indicator," Computing in Economics and Finance 2001 145, Society for Computational Economics.
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