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The Cost of Nominal Rigidity in NNS Models

  • MATTHEW B. CANZONERI
  • ROBERT E. CUMBY
  • BEHZAD T. DIBA

We present a model with Calvo wage and price setting, capital formation, and estimated rules for government spending and monetary policy. Our model captures many aspects of U.S. data, including the volatility that has been observed in various efficiency gaps. We estimate the cost of nominal rigidity-welfare under flexible wages and prices minus welfare with nominal rigidities-to be as much as 3% of consumption each period. Since there are interest rate rules that virtually eliminate this cost, our model suggests that-contrary to Lucas's (2003) assertion-there is considerable room for improvement in demand management policy. Copyright 2007 The Ohio State University.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1538-4616.2007.00079.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 39 (2007)
Issue (Month): 7 (October)
Pages: 1563-1586

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Handle: RePEc:mcb:jmoncb:v:39:y:2007:i:7:p:1563-1586
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  1. Marvin Goodfriend & Robert G. King, 2001. "The case for price stability," Working Paper 01-02, Federal Reserve Bank of Richmond.
  2. Tamim Bayoumi & Douglas Laxton & Paolo Pesenti, 2004. "Benefits and spillovers of greater competition in Europe: a macroeconomic assessment," International Finance Discussion Papers 803, Board of Governors of the Federal Reserve System (U.S.).
  3. 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.
  4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  5. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  6. Matthias Paustian, 2005. "The role of contracting schemes for the welfare costs of nominal rigidities," Computing in Economics and Finance 2005 196, Society for Computational Economics.
  7. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Working Papers 11523, National Bureau of Economic Research, Inc.
  8. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  9. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  10. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
  11. Paustian, Matthias, 2005. "The role of contracting schemes for the welfare costs of nominal rigidities over the business cycle," Discussion Paper Series 1: Economic Studies 2005,22, Deutsche Bundesbank, Research Centre.
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