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Another look at sticky prices and output persistence

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  • Peng-fei Wang
  • Yi Wen

Abstract

Price rigidity is the key mechanism for propagating business cycles in traditional Keynesian theory. Yet the New Keynesian literature has failed to show that sticky prices by themselves can effectively propagate business cycles in general equilibrium. We show that price rigidity in fact can (by itself) give rise to a strong propagation mechanism of the business cycle in standard New Keynesian models, provided that investment is also subject to a cash-in-advance constraint. In particular, we show that reasonable price stickiness can generate highly persistent, hump-shaped movements in output, investment and employment in response to either monetary or non-monetary shocks, even if investment is only partially cash-in-advance constrained. Hence, whether or not price rigidity is responsible for output persistence (and the business cycle in general) may not be a theoretical question, but an empirical one.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2005-051.

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Date of creation: 2005
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Publication status: Published in Journal of Economic Dynamics and Control, December 2006, 30(12), pp. 2533-52
Handle: RePEc:fip:fedlwp:2005-051

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Keywords: Prices ; Business cycles;

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Cited by:
  1. Belbute, José & Caleiro, António, 2010. "Cross Country Evidence on Consumption Persistence," MPRA Paper 22008, University Library of Munich, Germany.
  2. Arnab Bhattacharjee & Christoph Thoenissen, 2005. "Money and Monetary Policy in Stochastic General Equilibrium Models," CDMA Working Paper Series 200511, Centre for Dynamic Macroeconomic Analysis, revised 15 Feb 2007.
  3. Yunus Aksoy & Henrique S Basso & Javier Coto Matinez, 2009. "Liquidity Effects and Cost Channels in Monetary Transmission," Birkbeck Working Papers in Economics and Finance 0902, Birkbeck, Department of Economics, Mathematics & Statistics.
  4. Auray, Stéphane & de Blas, Beatriz, 2013. "Investment, matching and persistence in a modified cash-in-advance economy," Journal of Economic Dynamics and Control, Elsevier, vol. 37(3), pages 591-610.
  5. Belbute, José Manuel, 2013. "Is the Euro-Area core price index really more persistent than the food and energy price indexes?," Research in Economics, Elsevier, vol. 67(4), pages 307-315.
  6. Arnab Bhattacharjee & Christoph Thoenissen, 2007. "Money and Monetary Policy in DSGE Models," Money Macro and Finance (MMF) Research Group Conference 2006 78, Money Macro and Finance Research Group.
  7. Auray, Stephane & de Blas, Beatriz, 2007. "On Stickiness, Cash in Advance, and Persistence," Working Papers in Economic Theory 2007/05, Universidad Autónoma de Madrid (Spain), Department of Economic Analysis (Economic Theory and Economic History).
  8. Peng-fei Wang & Yi Wen, 2006. "Inflation dynamics: a cross-country investigation," Working Papers 2005-076, Federal Reserve Bank of St. Louis.
  9. Caleiro, António, 2009. "How upside down are political business cycles when there is output persistence," Research in Economics, Elsevier, vol. 63(1), pages 22-26, March.
  10. Belbute, José & Caleiro, António, 2009. "Measuring the Persistence on Consumption in Portugal," MPRA Paper 15116, University Library of Munich, Germany.

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