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Sticky prices and volatile output

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Martin Ellison
Andrew Scott

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Abstract

This paper examines the effect of introducing a specific type of price stickiness into a stochastic growth model subject to a cash-in-advance constraint. As in previous studies, it is found that the introduction of price rigidities provides a substantial source of monetary non-neutrality that contributes significantly to output volatility. It is shown that the introduction of this form of sticky prices improves the model's performance at explaining inflation, but worsens it for output. The most dramatic failure of the model is the extremely high-frequency fluctuations in output that it generates. Sticky prices not only fail to produce persistent business cycle fluctuations but they generate volatility at very high frequencies.

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Paper provided by Bank of England in its series Bank of England working papers with number 127.

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Handle: RePEc:boe:boeewp:127

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  4. Holland, Allison & Scott, Andrew, 1998. "The Determinants of UK Business Cycles," Economic Journal, Royal Economic Society, vol. 108(449), pages 1067-92, July. [Downloadable!] (restricted)
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  5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The Effects of Monetary Policy Shocks: Some Evidence from the Flow of Funds," NBER Working Papers 4699, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. King, Robert G & Watson, Mark W, 1996. "Money, Prices, Interest Rates and the Business Cycle," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 35-53, February. [Downloadable!] (restricted)
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  7. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April. [Downloadable!] (restricted)
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  10. Ball, Laurence & Romer, David, 1990. "Real Rigidities and the Non-neutrality of Money," Review of Economic Studies, Blackwell Publishing, vol. 57(2), pages 183-203, April. [Downloadable!] (restricted)
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  11. Strongin, Steven, 1995. "The identification of monetary policy disturbances explaining the liquidity puzzle," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 463-497, June. [Downloadable!] (restricted)
  12. Sims, Christopher A., 1992. "Interpreting the macroeconomic time series facts : The effects of monetary policy," European Economic Review, Elsevier, vol. 36(5), pages 975-1000, June. [Downloadable!] (restricted)
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  13. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June. [Downloadable!] (restricted)
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  14. Rotemberg, Julio J & Woodford, Michael, 1992. "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity," Journal of Political Economy, University of Chicago Press, vol. 100(6), pages 1153-1207, December. [Downloadable!] (restricted)
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  15. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 1994. "The effects of monetary policy shocks: evidence from the Flow of Funds," Working Paper Series, Macroeconomic Issues 94-2, Federal Reserve Bank of Chicago.
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  16. Haskel, Jonathan & Martin, Christopher & Small, Ian, 1995. "Price, Marginal Cost and the Business Cycle," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 57(1), pages 25-41, February.
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  1. Peter N. Ireland, 2002. "Endogenous Money or Sticky Prices?," NBER Working Papers 9390, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Juan Paez-Farrell, 2005. "New Keynesian Models and the test of Kydland and Prescott," Money Macro and Finance (MMF) Research Group Conference 2005 83, Money Macro and Finance Research Group. [Downloadable!]
  3. Peter Ireland & Niki Papadopoulou, 2004. "Sticky Prices vs Limited Participation: What do we Learn from the Data?," Working Papers 2004_4, Department of Economics, University of Glasgow. [Downloadable!]
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  4. Juan Paez-Farrell, 2003. "The New Keynesian Phillips Curve: Some Counterfactual Evidence," Macroeconomics 0312003, EconWPA. [Downloadable!]
  5. Livio Stracca, 2007. "Should we take inside money seriously?," Working Paper Series 841, European Central Bank. [Downloadable!]
  6. Ali Dib, 2001. "An Estimated Canadian DSGE Model with Nominal and Real Rigidities," Working Papers 01-26, Bank of Canada. [Downloadable!]
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  7. Wang, Peng-fei & Wen, Yi, 2004. "Another Look at Sticky Prices and Output Persistence," Working Papers 04-19, Cornell University, Center for Analytic Economics. [Downloadable!]
    Other versions:
  8. James M. Nason & Takashi Kano, 2004. "Business Cycle Implications of Habit Formation," Econometric Society 2004 Far Eastern Meetings 619, Econometric Society. [Downloadable!]
    Other versions:
  9. Stéphane Hallegatte & Michael Ghil, 2007. "Endogenous Business Cycles and the Economic Response to Exogenous Shocks," Working Papers 2007.20, Fondazione Eni Enrico Mattei. [Downloadable!]
  10. Carles Ibanez, 2007. "The Asymmetric Outcome of Sticky Price Models," Discussion Papers 07/19, Department of Economics, University of York. [Downloadable!]
  11. Niki X. Papadopoulou, 2008. "Sticky Prices, Limited Participation, or Both?," Working Papers 2008-4, Central Bank of Cyprus. [Downloadable!]
  12. Matheron,J. & Maury, P-M., 2004. "Evaluating the Fit of Sticky Price Models," Documents de Travail 104, Banque de France. [Downloadable!]
  13. Juan Paez-Farrell, 2003. "Monetary Policy and Business Cycle Analysis in an Optimising Model with Expectations Lags," Macroeconomics 0312002, EconWPA. [Downloadable!]
  14. James M. Nason & George A. Slotsve, 2004. "Along the New Keynesian Phillips Curve with nominal and real rigidities," Working Paper 2004-9, Federal Reserve Bank of Atlanta. [Downloadable!]
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  15. Lavan Mahadeva & Alex Muscatelli, 2005. "National Accounts Revisions and Output Gap Estimates in a Model of Monetary Policy with Data Uncertainty," Discussion Papers 14, Monetary Policy Committee Unit, Bank of England. [Downloadable!]
  16. Wang, Peng-fei & Wen, Yi, 2004. "Endogenous Money or Sticky Price? Comment on Monetary Non-neutrality and Inflation Dynamics," Working Papers 04-08, Cornell University, Center for Analytic Economics. [Downloadable!]
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  17. Niki Papadopoulou, 2004. "Sticky Prices, Limited Participation or Both?," Working Papers 2004_3, Department of Economics, University of Glasgow. [Downloadable!]
  18. Julien Matheron & Céline Poilly, 2006. "How Well Does a Small Structural Model with Sticky Prices and Wages Fit Postwar U.S. Data?," THEMA Working Papers 2006-11, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise. [Downloadable!]
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