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Explaining hump-shaped inflation responses to monetary policy shocks

  • James Yetman

    (University of Hong Kong, Hong Kong)

According to conventional wisdom, the output effects of a monetary policy shock commence within months of the shock, while most inflationary effects lag significantly. We demonstrate a simple model that can explain the conventional wisdom and is consistent with profit maximizing price setting decisions by firms, based on the assumption that renegotiating existing contracts is costly. Thus, firms jointly choose both their price and the expected length of time for which that price will hold each time they re-contract. We show that such a 'sticky contracting' assumption, combined with menu costs, generates a hump-shaped inflation response to monetary policy shocks. Copyright © 2007 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/mde.1326
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Article provided by John Wiley & Sons, Ltd. in its journal Managerial and Decision Economics.

Volume (Year): 28 (2007)
Issue (Month): 6 ()
Pages: 605-617

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Handle: RePEc:wly:mgtdec:v:28:y:2007:i:6:p:605-617
Contact details of provider: Web page: http://www3.interscience.wiley.com/cgi-bin/jhome/7976

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  1. Anil K. Kashyap, 1991. "Sticky prices: new evidence from retail catalogs," Working Paper Series, Macroeconomic Issues 91-26, Federal Reserve Bank of Chicago.
  2. Marco Bonomo & Carlos Viana de Carvalho, 2005. "Imperfectly Credible Disinflation under Endogenous Time-Dependent Pricing," Macroeconomics 0509005, EconWPA, revised 09 Sep 2005.
  3. Jean-Pascal Bénassy, 2003. "Staggered contracts and persistence : microeconomic foundations and macroeconomic dynamics," Recherches économiques de Louvain, De Boeck Université, vol. 69(2), pages 125-144.
  4. Michael C. Davis & James D. Hamilton, 2003. "Why Are Prices Sticky? The Dynamics of Wholesale Gasoline Prices," NBER Working Papers 9741, National Bureau of Economic Research, Inc.
  5. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips Curve," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1295-1328, November.
  6. Mankiw, N Gregory, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 529-38, May.
  7. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  8. Dutta, Shantanu, et al, 1999. "Menu Costs, Posted Prices, and Multiproduct Retailers," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(4), pages 683-703, November.
  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. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing And The General Equilibrium Dynamics Of Money And Output," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 655-690, May.
  11. Rotemberg, Julio J., 2005. "Customer anger at price increases, changes in the frequency of price adjustment and monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 829-852, May.
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