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Public's Inflation Expectations and Monetary Policy

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  • Leonardo Melosi

    (London Business School)

Abstract

The paper develops a DSGE model where monetary policy propagates by affecting and coordinating price setters' expectations. Price setters face costs of price adjustment and do not observe the history of technology, monetary, and preference shocks. They form expectations about the evolution of their nominal marginal costs observing their idiosyncratic productivity, which is correlated with the aggregate productivity, last period's output and inflation, and the interest rate set by the central bank according to a Taylor rule. The model is estimated through likelihood methods on a U.S. data set including the Survey of Professional Forecasters as a measure of price setters' expectations. The transmission channel based on price-setters' expectations is found to account for the following three empirical facts that have been documented by the VAR literature: (i) the delayed and persistent effects of monetary shocks on inflation with associated sluggish response of real output; (ii) the price puzzle; (iii) the disappearance of the price puzzle after the 1970s. Structural policies of disinflation, such as the introduction of an "inflation targeting", need to be backed up by a perfect commitment device to succeed.

Suggested Citation

  • Leonardo Melosi, 2011. "Public's Inflation Expectations and Monetary Policy," 2011 Meeting Papers 1151, Society for Economic Dynamics.
  • Handle: RePEc:red:sed011:1151
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    References listed on IDEAS

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    4. Bartosz Mackowiak & Mirko Wiederholt, 2009. "Optimal Sticky Prices under Rational Inattention," American Economic Review, American Economic Association, vol. 99(3), pages 769-803, June.
    5. Yuriy Gorodnichenko, 2008. "Endogenous information, menu costs and inflation persistence," NBER Working Papers 14184, National Bureau of Economic Research, Inc.
    6. Del Negro, Marco & Schorfheide, Frank, 2008. "Forming priors for DSGE models (and how it affects the assessment of nominal rigidities)," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1191-1208, October.
    7. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
    8. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-1370, November.
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    11. Morten Ravn & Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
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    13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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    Cited by:

    1. Leonardo Melosi & Francesco Bianchi, 2012. "Inflationary Sentiments and Monetary Policy Communcation," 2012 Meeting Papers 893, Society for Economic Dynamics.
    2. Kristoffer P. Nimark, 2014. "Man-Bites-Dog Business Cycles," American Economic Review, American Economic Association, vol. 104(8), pages 2320-2367, August.
    3. Stephen Millard & Eran Yashiv & Renato Faccini, 2012. "The New Keynesian Phillips Curve: the Role of Hiring and Investment Costs," 2012 Meeting Papers 556, Society for Economic Dynamics.

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