Nominal Rigidities Research Articles

Revisiting intertemporal elasticity of substitution in a sticky price model

Macroeconomic models typically assume additively separable preferences where consumption enters the utility function in a logarithmic form. This restriction implies that consumption growth is highly sensitive to movements in real interest rates, which in turn implies an unrealistically steep demand curve and intertemporal trade-off. We re-estimate the stylized New Keynesian Model with US data using King et al. (1988) preferences with and without habits and show that the equilibrium real interest rate elasticity of output is in the range of 0.05–0.20 in the US. Such low real interest rate elasticity is better in line with the empirical consumption Euler equation literature and implies relatively weak transmission of monetary policy to output and inflation.

Sovereign spreads and the effects of fiscal austerity

I analyze the impact of austerity on sovereign spreads. To do so I propose a model with strategic sovereign default and nominal rigidities, where the government follows fiscal rules, which are estimated from data. I first study theoretical implications and find that austerity can increase sovereign spreads, or be self-defeating, only when the decrease in government spending is persistent and the economy is expected to be in a recession with high fiscal multipliers. I then calibrate the model and use it to predict what would have happened to spreads and economic activity if Spain had continued to follow its pre-2010 fiscal rule instead of switching to the austerity track. I find that, relative to the counter-factual, austerity decreased sovereign spreads and debt-to-GDP ratios. Overall, I find that the likelihood of self-defeating austerities depends on the magnitude of fiscal multipliers and fiscal policy, but it is generally low.

The origin of the law of one price deviations: Insights from the good-level real exchange rate volatility

What is the origin of the law of one price deviation? To address this issue, this paper exploits the properties of good-level real exchange rate (RER) volatility; nominal (real) shocks predict the positive (negative) correlation between price stickiness and volatility. Using the US and 25 European countries, we estimate the contribution of each shock based on a two-country model in local currency pricing and the empirical analysis. The results indicate that the weighted average contribution of nominal shocks to the overall good-level RER volatility is 71%.

Optimal long-run inflation rate in an open economy

I analyze the long-run optimal inflation rate in the sticky price model with trend inflation and a two-country, two-good Ricardian trade structure. As in the closed-economy model, price stickiness effectively reduces an industry’s productivity under trend inflation. Contrary to the standard closed-economy models in which the optimal inflation rate is approximately zero, the model implies that the optimal rate is positive under certain conditions. Welfare gains come from manipulations of the terms of trade, and are hence associated with the loss of the trade partner. If the partner counter-acts, the allocation can be worse than what would occur under autarky.

The Paradox of Toil at the Zero Lower Bound in a TANK Model

This paper constructs a Two-Agent New Keynesian model in which the monetary authority implements a zero lower bound interest rate policy to examine whether the paradox of toil is present (i.e., whether a payroll tax cut policy is harmful to mitigating the effects of the Great Recession) during the zero lower bound period. Five notable findings emerge from the analysis. First, when the proportion of the rule-of-thumb (RoT) households is relatively small, the implementation of a payroll tax cut policy will further deepen the Great Recession. Second, when the proportion of RoT households is relatively large, the payroll tax cut policy can be a powerful policy instrument for alleviating the Great Recession. Third, as the evidence reveals a relatively large value of the proportion of RoT households in the U.S. (up to 30%), our numerical analysis calibrated to U.S. data demonstrates that the paradox of toil does not hold. Fourth, in association with either a lower profit share, a larger lump-sum tax share, a lower degree of price stickiness, or a higher probability of the shock remaining in its short run status, an additional payroll tax cut policy tends to generate a lower short-run output multiplier. Fifth, our extensions indicate that the validity of the paradox of toil is closely related to (i) the monopolistic profit and lump-sum tax distributions between RoT and optimizing households and (ii) whether the government balances its budget by levying lump-sum taxes or issuing government bonds.

Shocks versus Menu Costs: Patterns of Price Rigidity in an Estimated Multisector Menu-Cost Model

Abstract Sectoral heterogeneity matters for monetary policy. Using CPI microdata, we estimate for 227 products a time-varying menu-cost model to investigate the quantitative relevance of this heterogeneity. We find a substantial degree of cross-sectoral heterogeneity in all structural parameters. Heterogeneity in the Calvo component of the pricing friction is, however, the main source of heterogeneity in price rigidity. Cross-sectoral heterogeneity amplifies the output effect of a monetary shock by a factor of about 2.5, compared to a single-sector model estimated with mean moments. Heterogeneity in the Calvo parameter plays a key role in this amplification.

MONEY SUPPLY, INFLATION AND ECONOMIC GROWTH IN BOSNIA AND HERZEGOVINA: AN EMPIRICAL ANALYSIS

The analysis of monetary variables and their impact on the economic growth rate has always been in the focus of economic research. In the broadest sense, economic theory distinguishes two basic views defined by the views of monetarists and Keynesians. Although the basic difference is reflected in the determination of price rigidity and money neutrality, specifics of modern economic systems shift the focus towards the positive influence of monetary on real variables. The aim of our research is to identify and quantify the impact of monetary variables on economic growth in Bosnia and Herzegovina. The research was conducted using data from the period 2000-2020. The paper starts with the hypothesis that money supply and inflation ultimately have a positive impact on the real economic growth in BiH. The money supply M2 and the annual inflation rate are taken as explanatory (monetary) variables in the research, while real growth is a dependent variable. The long-term relationship between monetary variables and real growth rates was tested, taking into account the specificity of the BiH monetary arrangement established in the form of a currency board. In order to prove the hypothesis, we applied econometric techniques such as VEC model, cointegration analysis, innovation analysis based on the impulse-responsive function, decomposition variance as well as a causality test. The research results showed the connection between the money supply and the inflation rate with the economic growth in BiH, the relation being positive and statistically significant in the long run. With this, we confirmed the initial hypothesis of the work.

Socio – Economic Policy Response to Covid -19 in the Economic Commission for Community West Africa States (ECOWAS)

The macroeconomic impact of the COVID-19 epidemic in a quantitative dynamic period general equilibrium setup with nominal rigidities. Worldwide, the social and economic effects of the pandemic have been unprecedented, and Africa has not been spared. This study is aimed at assessing the socioeconomic impact of the Covid-19 pandemic in Africa with specific reference to four West African countries, Ghana Nigeria Senegal, and Mali. The study adopted qualitative research, through a systematic review of the literature. This was done by following a keyword search on literature that relates to the Covid 19 pandemic. The study confirmed that the covid-19 pandemic has had multiple negative socio-economic consequences in West Africa. It found that socially, the pandemic has increased inequality, and triggered sexual and gender-based violence against women and children. Economically, it had increased public debt, overburdened the health care system, and destroyed livelihoods. various containment policies were employed to dramatically reduce the welfare cost of the disease; social policy measures such provision of free meals, and cash donations to vulnerable groups were implemented, and public debt management mechanisms and stimulus packages were introduced.

High Inflation: Low Default Risk and Low Equity Valuations

AbstractWe develop an asset pricing model with endogenous corporate policies that explains how inflation jointly affects real asset prices and corporate default risk. Our model includes two empirically founded nominal rigidities: fixed nominal debt coupons (sticky leverage) and sticky cash flows. These two frictions result in lower real equity prices and credit spreads when expected inflation rises. A decrease in expected inflation has opposite effects, with even larger magnitudes. In the cross-section, the model predicts that the negative impact of higher expected inflation on real equity values is stronger for low leverage firms. We find empirical support for the model’s predictions.Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

The Inflation Effect of Exchange Rate and Price Stickiness in Turkey: NARDL Approach

Küreselleşme akımının etkisiyle birlikte ülkeler arasındaki sınırların ortadan kalkması uluslararası mal alışverişlerini hızlandırırken uluslararası alışverişler için gerekli döviz ihtiyacını da artırmaktadır. Bu durum döviz kurunda meydana gelen değişmelerin ekonomi üzerindeki etkisini artırmaktadır. Döviz kurlarında meydana gelen dalgalanmalar ithalata dayalı üretim ya da satış yapan endüstrilerde maliyet artışıyla birlikte yurtiçi fiyatları yükselterek bir enflasyonist sürecin yaşanmasına neden olmaktadır. Dolayısıyla bu çalışmada Türkiye’de 2013Q1-2021Q1 dönemi arasındaki enflasyon ile döviz kuru, ihracat ve ithalat arasındaki asimetrik ilişki NARDL yöntemi ile test edilmektedir. Çalışma sonucunda döviz kuru, ithalat ve ihracatın enflasyon üzerinde asimetrik etkisinin olduğu ve Türkiye’ de bu sürecin fiyat yapışkanlıklarına neden olduğu gözlemlenmiştir.

Current Account Imbalances, Real Exchange Rates, and Nominal Exchange Rate Variability

AbstractThis paper globally analyzes the bivariate relation between large current account imbalances and the real exchange rate over different degrees of nominal exchange rate variability. Employing both linear and nonlinear panel estimation procedures, we typically find an inverse long-run link between large imbalances and the real exchange rate at lower nominal exchange rate rigidity levels. This is in contrast to the often non-existent or positive comovement that materializes under lower nominal exchange rate variation. Our results thus suggest that greater nominal exchange rate adjustment can induce a stabilizing “current account”-“real exchange rate” relation. Meanwhile, current account adjustment speeds up with more flexible nominal exchange rates. Along the cross-section, the most salient findings are i) the striking positive relation between current account persistence and real exchange rate persistence based on country-specific estimates and ii) the inverse correlation between persistence in either the current account or real exchange rate and nominal exchange rate volatility.

A Generalized New Keynesian Model with Wage Stickiness

In this paper, we derive a generalized version of New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to study how real imperfections of labor market affect the steady state and dynamics of model given different non-zero annual target inflation rates. The main finding is that, given the same target inflation rate, wage stickiness is more distortionary than the price stickiness. The existence of positive target inflation rate can also change the first-order dynamics of model, amplifying or reducing the dynamic response of model according to the type of exogenous shocks. A relatively high target inflation rate, 2% or 3%, may be preferable to a zero target inflation rate.

Dynamic characteristics of China's inflation: a two-country DSGE model based on a multi-level vertical industrial structure

We establish a two-country DSGE model with a vertical production chain to study the inflation dynamics in China. By introducing multiple layers of price stickiness and shadow economy production to the vertical industrial chain, our model helps to explain dynamic characteristics of inflation. In our model, shocks can not only affect inflations by passing down the production chain through cost channels, but also in the reverse way due to the intermediate demand effect and the investment costs effects. After calibrating and estimating the parameters, the simulation results show that more than 90% of inflation fluctuations in China can be attributed to domestic shocks, among which the domestic monetary shock and final sector technology shock are the most influencing factors in explaining China’s inflation dynamics.

Consumption–investment comovement and the dynamic impact of monetary policy uncertainty in China

China's consumption weakly or negatively correlates with investment. We argue that monetary policy uncertainty (MPU) shock might partly explain this negative comovement. An identified shock to MPU in the structural vector autoregression (SVAR) model raises consumption but lowers investment and output, and the heavy industry sector suffers more adverse impacts than the light industry. We develop a multisector dynamic stochastic general equilibrium model to capture negative comovement by incorporating collateral constraints and real balance. The simulation responses replicate the empirical results, indicating that an increase in MPU reduces the attractiveness of loans (risky assets) and encourages agents to hold more liquidity and increase consumption. The liquidity premium is key to generating negative comovement, even in the absence of sticky prices, and differences in credit constraints or capital share could enhance negative comovement. Our findings have broad implications for China's business cycles and the theory of MPU.

Heterogeneity in sectoral price and quantity responses to shocks to monetary policy

This paper investigates the sectoral price and quantity responses to an exogenous interest rate shock in the United States. It has two main findings. First, an interest rate shock causes strong relative price effects in a non-negligible number of sectors whose price responses to the shock differ broadly from those of the aggregate. More importantly, such effects are present even four years after the shock. Second, sectoral differences in the frequency of price changes are only weakly associated with the sectoral price and quantity responses. We show that a multi-sector model equipped with a working-capital channel, sticky wages, and sectoral heterogeneity in the frequency of price changes and the structure of production costs can explain these two findings.

Market integration and price transmission in the regional grain markets in Ethiopia

ABSTRACT Persistent increases in basic food prices have become a critical challenge in Ethiopia since 2006. This paper assesses whether the structure of the grain market has contributed to the price increases. Traders having market power could create commodity price stickiness, implying that what goes up does not come down, leading to price increases. The study examines price linkages between principal grain markets in Ethiopia, using monthly prices from the wheat, maize, and teff markets. The Engle-Granger cointegration test is used to check for cointegration, while the Threshold Autoregressive Model is employed to investigate potential asymmetric price transmission. The findings indicate that major grain markets in Ethiopia are well integrated. Moreover, the threshold cointegration model reveals that they are characterized by symmetric adjustment. Hence, I argue that there is insufficient evidence to support the claim that market structure contributes to the price increase in Ethiopian grain markets.

Sentimental Business Cycles

We use fatalities in mass shootings in the U.S. as an instrument for autonomous declines in consumer confi dence to estimate the dynamic causal effects of sentiment shocks. Declining confi dence is recessionary and sets off a severe contraction in the labor market, while having less evident nominal effects. Sentiment shocks explain a non-negligible part of cyclical fluctuations. We demonstrate that in a model with heterogeneous agents, nominal rigidities and search-and-matching frictions, a wave of pessimism can take the economy from a normal state on a path towards a high-unemployment sunspot limit, inducing dynamics that resemble the empirical patterns.

Sticky wages in a world of ideas

This paper examines the implications of idea production and knowledge capital for monetary business cycles. We construct a sticky-wage model where workers produce goods based on firm-specific knowledge capital and researchers develop new ideas aided by economywide knowledge. As a quantitatively small group in the economy, researchers are inconsequential for the real effects of monetary shocks when the returns to research are low. However, when the returns to research are high, the result can be overturned. Monetary shocks can have significant real effects, even if wages are perfectly flexible for workers, who are quantitatively dominant in the economy.

Payroll tax shields and wage stickiness:evidence from China’s 2008 corporate income tax law

ABSTRACT Labor-cost adjustment has become an increasingly significant factor in enterprise development and economic growth, yet labor costs have proved ‘sticky’: more likely to rise with increasing revenue than fall when revenues decline. Although tax policies play an important role in wage determination, there is little research on how they affect wage stickiness. We treat China’s tax-reforming 2008 Corporate Income Tax Law as a shock and find that increases in nominal tax rates enhance wage stickiness in relation to ordinary employees but not executive compensation. The effect is most pronounced in enterprises with higher long-term debt ratios, state-owned enterprises, and labor-intensive industries.

Optimally sticky prices: Foundations

We propose a strategic microfoundation for sticky prices. We model an environment in which a firm has better information than its consumers and show that, when many consumers are uninformed, it is optimal for the firm to offer sticky contracts or sticky prices. We establish this result in a general mechanism design framework that allows for non-linear pricing and screening. A virtue of our microfoundation is that it is compatible with a dynamic general equilibrium model. We then discuss the implications of this microfounded friction for welfare.