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Temporary price changes and the real effects of monetary policy

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  • Patrick J. Kehoe
  • Virgiliu Midrigan

Abstract

In the data, prices change both temporarily and permanently. Standard Calvo models focus on permanent price changes and take one of two shortcuts when confronted with the data: drop temporary changes from the data or leave them in and treat them as permanent. We provide a menu cost model that includes motives for both types of price changes. Since this model accounts for the main regularities of price changes, its predictions for the real effects of monetary policy shocks are useful benchmarks against which to judge existing shortcuts. We find that neither shortcut comes close to these benchmarks. For monetary policy analysis, researchers should use a menu cost model like ours or at least a third, theory-based shortcut: set the Calvo model's parameters so that it generates the same real effects from monetary shocks as does the bench-mark menu cost model. Following either suggestion will improve monetary policy analysis.

Suggested Citation

  • Patrick J. Kehoe & Virgiliu Midrigan, 2008. "Temporary price changes and the real effects of monetary policy," Working Papers 413, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmwp:413
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    References listed on IDEAS

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    1. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
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    More about this item

    Keywords

    Keynesian economics; Prices;

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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