Temporary price changes and the real effects of monetary policy
AbstractIn the data, a large fraction of price changes are temporary. We provide a simple menu cost model which explicitly includes a motive for temporary price changes. We show that this simple model can account for the main regularities concerning temporary and permanent price changes. We use the model as a benchmark to evaluate existing shortcuts that do not explicitly model temporary price changes. One shortcut is to take the temporary changes out of the data and fit a simple Calvo model to it. If we do so prices change only every 50 weeks and the Calvo model overestimates the real effects of monetary shocks by almost 70%. A second shortcut is to leave the temporary changes in the data. If we do so prices change every 3 weeks and the Calvo model produces only 1/9 of the real effects of money as in our benchmark. We show that a simple Calvo model can generate the same real effects as our benchmark model if we set parameters so that prices change every 17 weeks.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Minneapolis in its series Working Papers with number 661.
Date of creation: 2008
Date of revision:
Other versions of this item:
- Patrick J. Kehoe & Virgiliu Midrigan, 2008. "Temporary price changes and the real effects of monetary policy," Working Papers 413, Federal Reserve Bank of Minneapolis.
- Patrick J. Kehoe & Virgiliu Midrigan, 2008. "Temporary Price Changes and the Real Effects of Monetary Policy," NBER Working Papers 14392, National Bureau of Economic Research, Inc.
- E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-05-17 (All new papers)
- NEP-CBA-2008-05-17 (Central Banking)
- NEP-DGE-2008-05-17 (Dynamic General Equilibrium)
- NEP-MAC-2008-05-17 (Macroeconomics)
- NEP-MON-2008-05-17 (Monetary Economics)
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