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The Cost of Tractability and the Calvo Pricing Assumption

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  • Fang Yao
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    Abstract

    This paper demonstrates that tractability gained from the Calvo pricing assumption is costly in terms of aggregate dynamics. I derive a generalized New Keynesian Phillips curve featuring a generalized hazard function, non-zero steady state inflation and real rigidity. An- alytically, I find that important dynamics in the NKPC are canceled out due to the restrictive Calvo assumption. I also present a general result, showing that, under certain conditions, this generalized Calvo pricing model generates the same aggregate dynamics as the gen- eralized Taylor model with heterogeneous price durations. The richer dynamic structure introduced by the non-constant hazards is also quantitatively important to the inflation dy- namics. Incorporation of real rigidity and trend inflation strengthen this effect even further. With reasonable parameter values, the model accounts for hump-shaped impulse responses of inflation to the monetary shock, and the real effects of monetary shocks are 2-3 times higher than those in the Calvo model.

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    File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2009-042.pdf
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    Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2009-042.

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    Length: 35 pages
    Date of creation: Sep 2009
    Date of revision:
    Handle: RePEc:hum:wpaper:sfb649dp2009-042
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    Keywords: Hazard function; Nominal rigidity; Real rigidity; New Keynesian Phillips curve;

    Find related papers by JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Calvo pricing is a costly assumption
      by Economic Logician in Economic Logic on 2009-10-27 14:15:00
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    Cited by:

    1. Fang Yao, 2010. "Aggregate Hazard Function in Price-Setting: A Bayesian Analysis Using Macro Data," SFB 649 Discussion Papers SFB649DP2010-020, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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    1. Economic Logic blog

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