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Sticky Price and Limited Participation Models of Money: A Comparison

  • Lawrence J. Christiano
  • Martin Eichenbaum
  • Charles L. Evans

This paper provides new evidence that models of the monetary transmission mechanism should be consistent with at least the following facts. In response to a contractionary monetary policy shock, the aggregate price level responds very little, aggregate output falls, interest rates initially rise, real wages decline, though by a modest amount, and profits fall. The paper argues that neither sticky price nor limited participation models can convincingly account for these facts. The key failing of the sticky price model is that it implies profits rise after a contractionary monetary policy shock. This finding is robust to a variety of perturbations of the benchmark sticky price model that we consider. In contrast, the limited participation model can account for all of the facts mentioned above. But it can do so only if one is willing to assume a high labor supply elasticity (2) and a high average markup (40%). The shortcomings of both models reflect the absence of other frictions, such as wage contracts, which dampen movements in the marginal cost of production after a monetary policy shock.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5804.

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Date of creation: Oct 1996
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Publication status: published as Christiano, Lawrence J., Martin Eichenbaum and Charles L. Evans. "Sticky Price And Limited Participation Models Of Money: A Comparison," European Economic Review, 1997, v41(6,Jun), 1201-1249.
Handle: RePEc:nbr:nberwo:5804
Note: EFG ME
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  21. 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.
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  25. Benhabib, Jess & Rogerson, Richard & Wright, Randall, 1991. "Homework in Macroeconomics: Household Production and Aggregate Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1166-87, December.
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  27. Pencavel, John, 1987. "Labor supply of men: A survey," Handbook of Labor Economics, in: O. Ashenfelter & R. Layard (ed.), Handbook of Labor Economics, edition 1, volume 1, chapter 1, pages 3-102 Elsevier.
  28. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Modeling money," Working Paper Series, Macroeconomic Issues WP-97-17, Federal Reserve Bank of Chicago.
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  30. Lawrence J. Christiano, 1991. "Modeling the liquidity effect of a money shock," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-34.
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