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Public's Inflation Expectations and Monetary Policy

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  • Leonardo Melosi

    (London Business School)

Abstract

The paper develops a DSGE model where monetary policy propagates by affecting and coordinating price setters' expectations. Price setters face costs of price adjustment and do not observe the history of technology, monetary, and preference shocks. They form expectations about the evolution of their nominal marginal costs observing their idiosyncratic productivity, which is correlated with the aggregate productivity, last period's output and inflation, and the interest rate set by the central bank according to a Taylor rule. The model is estimated through likelihood methods on a U.S. data set including the Survey of Professional Forecasters as a measure of price setters' expectations. The transmission channel based on price-setters' expectations is found to account for the following three empirical facts that have been documented by the VAR literature: (i) the delayed and persistent effects of monetary shocks on inflation with associated sluggish response of real output; (ii) the price puzzle; (iii) the disappearance of the price puzzle after the 1970s. Structural policies of disinflation, such as the introduction of an "inflation targeting", need to be backed up by a perfect commitment device to succeed.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1151.

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Date of creation: 2011
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Handle: RePEc:red:sed011:1151

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  1. Peter J. Klenow & Oleksiy Kryvtsov, 2005. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," NBER Working Papers 11043, National Bureau of Economic Research, Inc.
  2. James H. Stock & Mark W. Watson, 2001. "Vector Autoregressions," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 101-115, Fall.
  3. Luigi Paciello, 2009. "Monetary Policy and Price Responsiveness to Aggregate Shocks under Rational Inattention," EIEF Working Papers Series 0916, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2011.
  4. Ricardo Reis, 2009. "A Sticky-Information General-Equilibrium Model for Policy Analysis," NBER Working Papers 14732, National Bureau of Economic Research, Inc.
  5. Nimark, Kristoffer, 2008. "Dynamic pricing and imperfect common knowledge," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 365-382, March.
  6. Mirko Wiederholt & Emanuel Moench & Bartosz Maćkowiak, 2009. "Sectoral Price Data and Models of Price Setting," 2009 Meeting Papers 666, Society for Economic Dynamics.
  7. George-Marios Angeletos & Jennifer La'O, 2009. "Incomplete Information, Higher-Order Beliefs and Price Inertia," NBER Working Papers 15003, National Bureau of Economic Research, Inc.
  8. Adam, Klaus, 2004. "Optimal Monetary Policy with Imperfect Common Knowledge," CEPR Discussion Papers 4594, C.E.P.R. Discussion Papers.
  9. Yuriy Gorodnichenko, 2008. "Endogenous information, menu costs and inflation persistence," NBER Working Papers 14184, National Bureau of Economic Research, Inc.
  10. Morten O. Ravn & Stephanie Schmitt-Grohe, 2004. "Deep Habits," 2004 Meeting Papers 208, Society for Economic Dynamics.
  11. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  12. Klenow, Peter J. & Malin, Benjamin A., 2010. "Microeconomic Evidence on Price-Setting," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 6, pages 231-284 Elsevier.
  13. Kenneth L. Judd, 1998. "Numerical Methods in Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262100711, December.
  14. Efrem Castelnuovo & Paolo Surico, 2009. "Monetary Policy, Inflation Expectations and the Price Puzzle," "Marco Fanno" Working Papers 0101, Dipartimento di Scienze Economiche "Marco Fanno".
  15. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  16. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  17. Mirko Wiederholt, 2010. "rational inattention," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
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Cited by:
  1. Kristoffer Nimark, 2013. "Man-Bites-Dog Business Cycle," Working Papers 700, Barcelona Graduate School of Economics.
  2. Stephen Millard & Eran Yashiv & Renato Faccini, 2012. "The New Keynesian Phillips Curve: the Role of Hiring and Investment Costs," 2012 Meeting Papers 556, Society for Economic Dynamics.
  3. Leonardo Melosi & Francesco Bianchi, 2012. "Inflationary Sentiments and Monetary Policy Communcation," 2012 Meeting Papers 893, Society for Economic Dynamics.

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