Sticky-price models and the natural rate hypothesis

Andres, Javier; López-Salido, J. David; Nelson, Edward

Working Paper

Sticky-price models and the natural rate hypothesis

Abstract: A major criticism of standard specifications of price adjustment in models for monetary policy analysis is that they violate the natural rate hypothesis by allowing output to differ from potential in steady state. In this paper we estimate a dynamic optimizing business cycle model whose price-setting behavior satisfies the natural rate hypothesis. The price-adjustment specifications we consider are the sticky-information specification of Mankiw and Reis (2002) and the indexed contracts of Christiano, Eichenbaum, and Evans (2005). Our empirical estimates of the real side of the economy are similar whichever price adjustment specification is chosen. Consequently, the alternative model specifications deliver similar estimates of the U.S. output gap series, but the empirical behavior of the gap series differs substantially from standard gap estimates.

Keywords: Monetary policy; Prices;

Status: Published in Journal of Monetary Economics, July 2005, 52(5), pp. 1025-53