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Monetary Policy, Inflation Expectations and the Price Puzzle

Listed author(s):
  • Efrem Castelnuovo

    ()

    (University of Padua)

  • Paolo Surico

    ()

    (London Business School)

This paper re-examines the VAR evidence on the price puzzle and proposes a new theoretical interpretation. Using actual data and two identification strategies based on zero restrictions and model-consistent sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the sub-samples that are typically associated with a weak interest rate response to inflation. Using pseudo data generated by a sticky price model of the U.S. economy, we then show that the structural VARs are capable of reproducing the price puzzle only when monetary policy is passive. The omission in the VARs of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data.

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Paper provided by Dipartimento di Scienze Economiche "Marco Fanno" in its series "Marco Fanno" Working Papers with number 0101.

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Length: 28 pages
Date of creation: Sep 2009
Handle: RePEc:pad:wpaper:0101
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  17. Efrem Castelnuovo & Paolo Surico, 2005. "The Price Puzzle: Fact or Artefact?," Macroeconomics 0505015, EconWPA, revised 19 Jul 2005.
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  29. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
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