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Sticky Prices vs. Limited Participation:What Do We Learn From the Data?

  • Niki Papadopoulou

    (Central Bank of Cyprus and University of Cyprus)

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    The method of maximum likelihood is used to estimate a Dynamic Stochastic General Equilibrium business cycle model that combines elements of existing sticky-price and limited-participation specifications. Sticky prices are incorporated, following Rotemberg (1982), by assuming that monopolistically competitive firms face a quadratic cost of nominal price adjustment. Limited participation is incorporated, following Cooley and Quadrini (1999), by assuming that households face a quadratic cost of portfolio adjustment.The results support the hypothesis that the degree of the portfolio adjustment is very small in the data, but significant. In addition, the data suggest that the response of the interest rate to deviations of output from the steady state in the interest rate rule should be very close to zero. This is argued by Christiano and Gust (1999) as well. Furthermore, as in Ireland (1999, 2000), the model can not reject the hypothesis of parameter stability for the policy parameters. On the other hand, the model rejects the hypothesis for the rest of the parameters

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    Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 418.

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    Date of creation: 04 Jul 2006
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    Handle: RePEc:sce:scecfa:418
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    1. Christiano, Lawrence J & Eichenbaum, Martin, 1995. "Liquidity Effects, Monetary Policy, and the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 1113-36, November.
    2. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
    3. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    4. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1996. "Sticky price and limited participation models of money: a comparison," Working Paper Series, Macroeconomic Issues WP-96-28, Federal Reserve Bank of Chicago.
    5. Robert G. King & Mark W. Watson, 1995. "Money, prices, interest rates and the business cycle," Working Paper Series, Macroeconomic Issues 95-10, Federal Reserve Bank of Chicago.
    6. Hendry, S. & Zhang, G., 1998. "Liquidity Effects and Market Frictions," Working Papers 98-11, Bank of Canada.
    7. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 83-108, December.
    8. Boivin, Jean & Giannoni, Marc, 2006. "Has Monetary Policy Become More Effective?," CEPR Discussion Papers 5463, C.E.P.R. Discussion Papers.
    9. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Monetary policy shocks: what have we learned and to what end?," Working Paper Series, Macroeconomic Issues WP-97-18, Federal Reserve Bank of Chicago.
    10. Andrews, Donald W K & Fair, Ray C, 1988. "Inference in Nonlinear Econometric Models with Structural Change," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 615-39, October.
    11. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis.
    12. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," Working Papers 97-32, C.V. Starr Center for Applied Economics, New York University.
    13. Peter N. Ireland, 2000. "Sticky-Price Models of the Business Cycle: Specification and Stability," NBER Working Papers 7511, National Bureau of Economic Research, Inc.
    14. Martin Ellison & Andrew Scott, 2001. "Sticky prices and volatile output," Bank of England working papers 127, Bank of England.
    15. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
    16. Cooley, Thomas F. & Quadrini, Vincenzo, 1999. "A neoclassical model of the Phillips curve relation," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 165-193, October.
    17. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
    18. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
    19. Peter N. Ireland, 1999. "A method for taking models to the data," Working Paper 9903, Federal Reserve Bank of Cleveland.
    20. Lawrence J. Christiano & Christopher J. Gust, 1999. "Taylor Rules in a Limited Participation Model," NBER Working Papers 7017, National Bureau of Economic Research, Inc.
    21. Bennett T. McCallum, 1999. "Analysis of the Monetary Transmission Mechanism: Methodological Issues," NBER Working Papers 7395, National Bureau of Economic Research, Inc.
    22. Jinill Kim, 1998. "Monetary policy in a stochastic equilibrium model with real and nominal rigidities," Finance and Economics Discussion Series 1998-02, Board of Governors of the Federal Reserve System (U.S.).
    23. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
    24. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
    25. Keen, Benjamin D., 2004. "In search of the liquidity effect in a modern monetary model," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1467-1494, October.
    26. Rotemberg, Julio J, 1982. "Sticky Prices in the United States," Journal of Political Economy, University of Chicago Press, vol. 90(6), pages 1187-1211, December.
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