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Nominal Rigidities, Monetary Policy and Pigou Cycles

Author

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  • Stephane Auray

    () (EQUIPPE (EA 4018), Universités Lille Nord de France (ULCO), GREDI, Université de Sherbrooke and CIRP\Eacute;E.)

  • Paul Gomme

    () (Concordia University and CIREQ)

  • Shen Guo

    () (China Academy of Public Finance and Public Policy, Central University of Finance and Economics, Beijing, China)

Abstract

Based on a two sector dynamic new Keynesian model with sticky prices, this paper makes two contributions to the Pigou cycle literature. First, the paper quantifies the contribution of `news shocks' -- signals of future productivity changes. Maximum likelihood estimates indicate that nondurable sector news shocks are roughly as volatile as contemporary shocks; in the durable good sector, the standard deviation of news shocks is 1/4 that of contemporaneous shocks. Second, and perhaps more importantly, the paper shows that the estimated interest rule contributes to Pigou cycles arising from nondurable sector news shocks. In particular, the Ramsey-optimal policy does not exhibit Pigou cycles while the estimated policy rule does. With sticky prices, intermediate good producers set current prices based on expected future marginal cost. The news shock implies a lower future marginal cost, and so nondurable goods prices start falling immediately. The estimated interest rate rule then prescribes a lower nominal interest rate, and so a fall in both the real interest rate and user cost of durables. As a result, purchases of durables also rise. In contrast, the Ramsey-optimal policy requires a higher nominal interest rate because the Ramsey policy attempts to minimize the distortions associated with within-sector price dispersion. The resulting dynamics under the Ramsey policy are, then, essentially the opposite of those under the estimated policy. Put simply, Pigou cycles arise in the model precisely because the central bank accommodates them.

Suggested Citation

  • Stephane Auray & Paul Gomme & Shen Guo, 2009. "Nominal Rigidities, Monetary Policy and Pigou Cycles," Working Papers 09005, Concordia University, Department of Economics, revised 06 Apr 2010.
  • Handle: RePEc:crd:wpaper:09005
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    Cited by:

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    2. Paul Beaudry & Franck Portier, 2014. "News-Driven Business Cycles: Insights and Challenges," Journal of Economic Literature, American Economic Association, vol. 52(4), pages 993-1074, December.
    3. Accolley, Delali, 2018. "Accounting for Busines Cycles in Canada: II. The Role of Money," MPRA Paper 85481, University Library of Munich, Germany.
    4. Fan, Haichao & Gao, Xiang & Xu, Juanyi & Xu, Zhiwei, 2016. "News shock, firm dynamics and business cycles: Evidence and theory," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 159-180.
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    6. Cantelmo, Alessandro & Melina, Giovanni, 2018. "Monetary policy and the relative price of durable goods," Journal of Economic Dynamics and Control, Elsevier, vol. 86(C), pages 1-48.
    7. Chen, Kaiji & Song, Zheng, 2013. "Financial frictions on capital allocation: A transmission mechanism of TFP fluctuations," Journal of Monetary Economics, Elsevier, vol. 60(6), pages 683-703.

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    More about this item

    Keywords

    Pigou cycles; monetary policy;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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