Working Paper

Another look at sticky prices and output persistence

Abstract: Price rigidity is the key mechanism for propagating business cycles in traditional Keynesian theory. Yet the New Keynesian literature has failed to show that sticky prices by themselves can effectively propagate business cycles in general equilibrium. We show that price rigidity in fact can (by itself) give rise to a strong propagation mechanism of the business cycle in standard New Keynesian models, provided that investment is also subject to a cash-in-advance constraint. In particular, we show that reasonable price stickiness can generate highly persistent, hump-shaped movements in output, investment and employment in response to either monetary or non-monetary shocks, even if investment is only partially cash-in-advance constrained. Hence, whether or not price rigidity is responsible for output persistence (and the business cycle in general) may not be a theoretical question, but an empirical one.

Keywords: Prices; Business cycles;

Status: Published in Journal of Economic Dynamics and Control, December 2006, 30(12), pp. 2533-52

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2005

Number: 2005-051