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How Well Does Sticky Information Explain Inflation and Output Inertia?

  • Carrillo Julio A.

    (METEOR)

This paper compares two approaches that aim to explain the lagged and persistent behaviorof inflation and output after a variation in the interest rate. Two variants that produce inertiaare added to a baseline DSGE model of sticky prices: 1) a lagged inflation indexation rulealong with habit formation; and 2) sticky information applied to firms, workers, and households. The rival models are then confronted to a monetary SVAR using U.S. data in order to estimate the rates of inflation indexation, habit formation, price rigidities, information stickiness, and the monetary policy rule parameters. It is shown that the sticky information model has a modest advantage at fitting inflation than the lagged inflation index. model with habits. For output, the opposite is true. These differences are consistent throughout the robustness analysis, but they are not big enough to imply a significant statistical difference in terms of the goodness of fit of each model. In addition, the results suggest that sticky information may replace entirely sticky prices as a explanation of price setting behavior, but the latter might not apply to wages. Finally, the analysis find that information stickiness should be pervasive (i.e., applied to households, firms, and workers) in order to replicate the responses of aggregate variables to a shock in monetary policy.

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Paper provided by Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR) in its series Research Memorandum with number 018.

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Date of creation: 2010
Handle: RePEc:unm:umamet:2010018
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