Monetary Policy, Inflation Expectations and the Price Puzzle
AbstractThis paper re-examines the VAR evidence on the price puzzle and proposes a new theoretical interpretation. Using actual data and two identification strategies based on zero restrictions and model-consistent sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the sub-samples that are typically associated with a weak interest rate response to inflation. Using pseudo data generated by a sticky price model of the U.S. economy, we then show that the structural VARs are capable of reproducing the price puzzle only when monetary policy is passive. The omission in the VARs of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data.
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Bibliographic InfoPaper provided by Dipartimento di Scienze Economiche "Marco Fanno" in its series "Marco Fanno" Working Papers with number 0101.
Length: 28 pages
Date of creation: Sep 2009
Date of revision:
Other versions of this item:
- Efrem Castelnuovo & Paolo Surico, 2010. "Monetary Policy, Inflation Expectations and The Price Puzzle," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 120(549), pages 1262-1283, December.
- Castelnuovo, Efrem & Surico, Paolo, 2009. "Monetary policy, inflation expectations and the price puzzle," Research Discussion Papers, Bank of Finland 30/2009, Bank of Finland.
- E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-09-26 (All new papers)
- NEP-CBA-2009-09-26 (Central Banking)
- NEP-MAC-2009-09-26 (Macroeconomics)
- NEP-MON-2009-09-26 (Monetary Economics)
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