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Monetary Shocks with Observation and menu Costs

  • Fernando Alvarez

    (University of Chicago and NBER)

  • Francesco Lippi

    (University of Sassari and EIEF)

  • Luigi Paciello

    (EIEF)

We compute the impulse response of output to an aggregate monetary shock in a general equilibrium when firms set prices subject to a costly observation of the state and a menu cost. We study how the aggregate effects of a monetary shock depend on the relative size of these costs. We find that empirically reasonable observations costs increase the impact and the persistence of the output response to monetary shocks compared to models with menu cost only, flattening the shape of the impulse response function. Moreover we show that if the shocks are not large the results are independent of the assumption of whether firms know the realization of the monetary shock on impact.

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Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1310.

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Length: 58 pages
Date of creation: 2013
Date of revision: May 2013
Handle: RePEc:eie:wpaper:1310
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