Working Paper: CEPR ID: DP15551
Authors: Vo Phuong Mai Le; Patrick Minford; David Meenagh
Abstract: Strong evidence exists that price/wage durations are dependent on the state of the economy, especially inflation. We embed this dependence in a macro model of the US that otherwise does well in matchingthe economy's behaviour in the last three decades; it now also matches it over the whole post-warperiod. This finding implies a major new role for monetary policy: besides controlling inflation it nowdetermines the economy's price stickiness. We find that, when backed by fiscal policy in preventing aZLB, by targeting nominal GDP monetary policy can achieve high price stability and avoid large cyclicaloutput fluctuations.
Keywords: state-dependence; New Keynesian; rational expectations; crises; price stability; nominal GDP
JEL Codes: E2; E3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy (E52) | price stickiness (L11) |
| monetary policy (E52) | inflation (E31) |
| inflation (E31) | price-setting behavior (L11) |
| price stickiness (L11) | output fluctuations (E39) |
| monetary policy (E52) | output fluctuations (E39) |
| inflation (E31) | variance of idiosyncratic shocks (D89) |
| variance of idiosyncratic shocks (D89) | price adjustments (L11) |
| price-setting behavior (L11) | economic stability (E63) |