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On the Transmission of Monetary Policy Shocks

Empirical studies reveal that monetary policy shocks generate long-lasting effects on real GDP, countercyclical real wages before World War II and procyclical real wages afterwards. In this paper, we construct a dynamic general equilibrium model to explain the observed output persistence and the evolving nature of real wage cyclicality. The model features three important rigidities: staggered price-setting, staggered wage-setting, and an input-output structure. We show that, while no subset of the model with fewer ingredients can produce both the desired patterns of real wage dynamics and persistent movements in aggregate output, the model with all three features successfully accounts for these empirical regularities. In particular, it explains how the real wage can change from being countercyclical or acyclical to being procyclical as the input-output structure becomes more sophisticated, while at the same time delivering significant output persistence. The ascending sophistication of the input-output structure in the model mimics the rising complexity of the input-output connections from the prewar period to the postwar period in the actual economies, a trend that is documented in the literature.

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Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 112.

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Length: 25 pages
Date of creation: May 2000
Date of revision: Sep 2001
Handle: RePEc:cre:crefwp:112
Note: Previously circulated under the title "Staggered Contracts, Intermediate Goods, and the Dynamic Effects of Monetary Shocks on Output, Inflation, and Real Wages"
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  1. Basu, S., 1993. "Intermediate Goods and Business Cycles: Implications for Productivity and Welfare," Papers 93-23, Michigan - Center for Research on Economic & Social Theory.
  2. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky Price and Limited Participation Models of Money: A Comparison," NBER Working Papers 5804, National Bureau of Economic Research, Inc.
  3. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
  4. Susanto Basu & Alan M. Taylor, 1999. "Business Cycles in International Historical Perspective," NBER Working Papers 7090, National Bureau of Economic Research, Inc.
  5. Kevin Huang & Z. Liu, . "Staggered contracts and business cycle persistence," Working Papers 2000-08, Utah State University, Department of Economics.
  6. Michael D. Bordo & Christopher J. Erceg & Charles L. Evans, 1997. "Money, sticky wages, and the Great Depression," International Finance Discussion Papers 591, Board of Governors of the Federal Reserve System (U.S.).
  7. John B. Taylor, 1998. "Staggered Price and Wage Setting in Macroeconomics," NBER Working Papers 6754, National Bureau of Economic Research, Inc.
  8. Sims, Christopher A., 1992. "Interpreting the macroeconomic time series facts : The effects of monetary policy," European Economic Review, Elsevier, vol. 36(5), pages 975-1000, June.
  9. Robert Feenstra & Paul Bergin, 2004. "staggered price setting and endogenous persistence," Working Papers 985, University of California, Davis, Department of Economics.
  10. Olivier Jean Blanchard & Danny Quah, 1988. "The Dynamic Effects of Aggregate Demand and Supply Disturbance," Working papers 497, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Olivier J. Blanchard, 1982. "Price Asynchronization and Price Level Inertia," NBER Working Papers 0900, National Bureau of Economic Research, Inc.
  12. Barro, Robert J & Grossman, Herschel I, 1971. "A General Disequilibrium Model of Income and Employment," American Economic Review, American Economic Association, vol. 61(1), pages 82-93, March.
  13. Michael T. Kiley, 1996. "Endogenous price stickiness and business cycle persistence," Finance and Economics Discussion Series 96-23, Board of Governors of the Federal Reserve System (U.S.).
  14. Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
  15. Gali, Jordi, 1992. "How Well Does the IS-LM Model Fit Postwar U.S. Data," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 709-38, May.
  16. Ben S. Bernanke & Kevin Carey, 1996. "Nominal Wage Stickiness and Aggregate Supply in the Great Depression," NBER Working Papers 5439, National Bureau of Economic Research, Inc.
  17. King, Robert G., 1988. "Money demand in the United States: A quantitative review," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 169-172, January.
  18. Lucas, Robert E., 1988. "Money demand in the United States: A quantitative review," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 29(1), pages 137-167, January.
  19. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
  20. Gordon, Robert J, 1990. "What Is New-Keynesian Economics?," Journal of Economic Literature, American Economic Association, vol. 28(3), pages 1115-71, September.
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