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Time-varying business volatility, price setting, and the real effects of monetary policy

  • Bachmann, Rüdiger
  • Born, Benjamin
  • Elstner, Steffen
  • Grimme, Christian

Does time-varying business volatility affect the price setting of firms and thus the transmission of monetary policy into the real economy? To address this question, we estimate from the firm-level micro data of the German IFO Business Climate Survey the impact of idiosyncratic volatility on the price setting behavior of firms. In a second step, we use a calibrated New Keynesian business cycle model to gauge the effects of time-varying volatility on the transmission of monetary policy to output. Our results are twofold. Heightened business volatility increases the probability of a price change, though the effect is small: the tripling of volatility during the recession of 08/09 caused the average quarterly likelihood of a price change to increase from 31.6% to 32.3%. Second, the effects of this increase in volatility on monetary policy are also small; the initial effect of a 25 basis point monetary policy shock to output declines from 0.347% to 0.341%.

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Paper provided by German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung in its series Working Papers with number 01/2013.

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Date of creation: 2013
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Handle: RePEc:zbw:svrwwp:012013
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