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How robust are popular models of nominal frictions?

  • Benjamin D. Keen
  • Evan F. Koenig

This paper analyzes three popular models of nominal price and wage frictions to determine which best fits post-war U.S. data. We construct a dynamic stochastic general equilibrium (DSGE) model and use maximum likelihood to estimate each model's parameters. Because previous research finds that the conduct of monetary policy and the behavior of inflation changed in the early 1980s, we examine two distinct sample periods. Using a Bayesian, pseudo-odds measure as a means for comparison, a sticky price and wage model with dynamic indexation best fits the data in the early-sample period, whereas either a sticky price and wage model with static indexation or a sticky information model best fits the data in the late-sample period. Our results suggest that price- and wage-setting behavior may be sensitive to changes in the monetary policy regime. If true, the evaluation of alternative monetary policy rules may be even more complicated than previously believed.

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File URL: http://dallasfed.org/assets/documents/research/papers/2009/wp0903.pdf
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Paper provided by Federal Reserve Bank of Dallas in its series Working Papers with number 0903.

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Date of creation: 2009
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Handle: RePEc:fip:feddwp:0903
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  9. Olivier Coibion & Yuriy Gorodnichenko, 2010. "Monetary Policy, Trend Inflation and the Great Moderation:An Alternative Interpretation," Working Papers 94, Department of Economics, College of William and Mary.
  10. Altig, David E & Christiano, Lawrence J. & Eichenbaum, Martin & Lindé, Jesper, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," CEPR Discussion Papers 4858, C.E.P.R. Discussion Papers.
  11. Martin Evans & Paul Wachtel, 1993. "Inflation regimes and the sources of inflation uncertainty," Proceedings, Federal Reserve Bank of Cleveland, pages 475-520.
  12. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
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  21. Benjamin D. Keen, 2007. "Sticky Price And Sticky Information Price-Setting Models: What Is The Difference?," Economic Inquiry, Western Economic Association International, vol. 45(4), pages 770-786, October.
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