international competition and real wages myriad politicians express concern over increased competition from abroad but among economists the home economy is widely believed to benefit from improvement in foreign economies jeffrey williamson 1991 work by a few economists john r hicks 1953 ronald jones 1979 paul krugman 1979 suggests that there is some truth to popular concerns over competitiveness the effect of foreign competition in reducing the relative price of the goods that the united states formerly exported can lower aggregate real income in the united states even as world income rises accordingly the success of japan western europe and more recently many other nations in producing goods that were as of the end of world war ii virtual monopolies of the united states is another potential candidate for explaining the fall relative to trend of the average living standard or real wage in the united states

the tail index of exchange rate returns in the literature on the empirical distribution of foreign exchange rates there is now consensus that exchange rate yields are fat tailed three problems however persist 1 which class of distribution functions is most appropriate 2 are the parameters of the distribution invariant over subperiods 3 what are the effects of aggregation over time on the distribution in this paper we employ extreme value theory to shed new light on these questions we apply the theoretical results to ems data

the inexorable and mysterious tradeoff between inflation and unemployment this paper discusses the short run tradeoff between inflation and unemployment although this tradeoff remains a necessary building block of business cycle theory economists have yet to provide a completely satisfactory explanation for it according to the consensus view among central bankers and monetary economists a contractionary monetary shock raises unemployment at least temporarily and leads to a delayed and gradual fall in inflation standard dynamic models of price adjustment however cannot explain this pattern of responses reconciling the consensus view about the effects of monetary policy with models of price adjustment remains an outstanding puzzle for business cycle theorists several years ago i gave myself a peculiar assignment i decided to try to summarise all of economics in ten simply stated principles the purpose of this task was to introduce students to the economic way of thinking in the first chapter of my textbook principles of economics i figured if god could boil all of moral philosophy down to ten commandments i should be able to do much the same with economic science most of the ten principles i chose were microeconomic and hard to argue with they involved the importance of tradeoffs marginal analysis the benefits of trade market efficiency market failure and so on i allocated the last three principles to macroeconomics the first of these was a country s standard of living depends on its ability to produce goods and services which i viewed as the foundation of all growth theory the second was prices rise when the government prints too much money which i took to be the essence of classical monetary theory the last of my ten principles is the subject of today s lecture society faces a short run tradeoff between inflation and unemployment perhaps not surprisingly this statement turned out to be controversial when my publisher sent out the manuscript for review a few readers objected

real rigidities and the non neutrality of money rigidities in real prices are not sufficient to create rigidities in nominal prices and real effects of nominal shocks and by themselves small frictions in nominal adjustment such as costs of changing prices create only small non neutralities but this paper shows that substantial nominal rigidity can arise from a combination of real rigidities and small nominal frictions the paper shows the connection between real and nominal rigidity given the presence of nominal frictions both in general and for two specific sources of real rigidity one arising from goods market imperfections and the other from labour market imperfections

the behavior of prices and inflation an empirical analysis of disaggregat price data this paper analyzes the effects of inflation on the dispersion of prices as well as other aspects of price behavior using disaggregated data on prices of foodstuffs in israel during 1978 84 we find that the effect of expected inflation on intramarket price variability is stronger than the effect of unexpected inflation we show that even in times of high inflation price quotations are not trivially short and price changes are not synchronized across firms these facts taken together confirm that there is some staggering in the setting of prices we find that the distribution of real prices is far from being uniform as many menu cost based models assume or conclude in fact as inflation increases to very high levels this distribution is not even symmetric when the annual inflation rate reaches 130 percent there are equal chances of finding real prices above or below the market average but upward deviations in the real price are further away from zero than downward ones furthermore as the annu

price and wage inflation persistence across countries and monetary regimes abstract we augmented a macro model with intrinsic inflation inertia assuming that prices farer in the past are more likely to be reset we estimated the model for seven industrialized economies to compare their price wage structures and to explore the potential nexus between changes the price wage structure and changes in policy stances we find evidence for duration dependent price adjustments in all the country of the sample although positively sloped after few periods price hazard functions often become flat as in calvo based models instead wage hazard shapes are in line with taylor contracts with the exceptions of france and the united kingdom country comparison shows that price and wage stickiness are correlated regarding monetary policy stances no systematic effect is found observed changes are explained by country specific factors e g market reforms

empirical evidence on inflation expectations in the new keynesian phillips curve abstract we review the main identification strategies and empirical evidence on the role of expectations in the new keynesian phillips curve paying particular attention to the issue of weak identi

analytical approximations in models of hysteresis decisions made under ongoing uncertainty and costly reversibility entail a range of the state variable where inaction is optimal which in turn produces hysteresis permanent effects of temporary shifts the range is usually defined by non linear equations that need numerical solutions in this paper a technique of analytical approximations is developed and applied to two models menu costs and investment the resulting explicit solutions help clarify why hysteresis is important even for small irreversibility in the menu cost model hysteresis is two orders of magnitude larger than under the akerlof yellen or mankiw assumptions when decisions that are costly to reverse are made under conditions of ongoing uncertainty the optimum policy usually entails a range of inertia the action should be taken only when the value of the underlying state variable becomes especially favourable and reversed only when it becomes especially unfavourable there is an intermediate range over which inaction is optimal this in turn gives rise to hysteresis starting from a value in the range of inertia if the state variable crosses the action trigger point and then returns to its original level the action will be taken but not reversed thus a temporary change will leave a permanent effect numerical solutions for models of irreversible investment show that the range of inaction is remarkably large even when the cost of reversal is small see brennan and schwartz 1985 constantinides 1986 and dixit 1989a b for examples of this unfortunately the equations tlhat determine the optimum policy are highly non linear they do not have analytical solutions therefore we lack a clearer and more general understanding of why hysteresis is numerically so important in this paper i derive analytical approximations for the solutions of more general problems of this kind when the costs of change are small the idea that small costs of change induce large amounts of inertia has been popularized in the model of akerlof and yellen 1985 mankiw 1985 and others in these models second order small costs of making price changes yield price stickiness in response to first order changes in the money supply this is a simple application of the envelope theorem but these models are static and their application to a dynamic reality must assume either permanent shocks or static expectations when there is ongoing uncertainty which is rationally expected by the decision maker the option value of the status quo enlarges the zone where inaction is optimal adding these features to the mankiw akerlof yellen may model i show that fourth order small costs of change generate first order inertia

a damped diffusion framework for financial modeling and closed form maximum likelihood estimation abstract asset price bubbles can arise unintentionally when one uses continuous time diffusion processes to model financial quantities we propose a flexible damped diffusion framework that is able to break many types of bubbles and preserve the martingale pricing approach damping can be done on either the diffusion or drift function oftentimes certain solutions to the valuation pde can be ruled out by requiring the solution to be a limit of martingale prices for damped diffusion models monte carlo study shows that with finite time series length maximum likelihood estimation often fails to detect the damped diffusion function while fabricates nonlinear drift function an alternative method based on ait sahalia s specification test on parametric models is proposed

search sticky prices and inflation this paper examines equilibrium in a deflationary environment in a market with free entry where consumers search and firms set prices on individual units of the commodity prices attached to newly produced goods are continuously adjusted prices attached to previously produced goods can only be changed at a cost deflation cuts into the market power created by the need to search for the good thus consumers welfare is inverse u shaped in deflation

labour s reward across regions of the eu a distributional dynamic approach a large number of empirical studies have tested for the presence of convergence for a variety of economic variables this paper examines the evolution of labour s reward across regions of the eu to identify whether factor price convergence has occurred density diagrams are used to illustrate static distributions while transitional matrices are employed to identify movements of the distribution over time the results presented suggest that the evolutionary paths of average regional pay are fairly stable with stratification and persistence identified as important characteristics there was uninterrupted convergence of average regional pay between 1980 1992 however between 1992 1994 this process reversed

the phillips curve under state dependent pricing abstract we derive a phillips curve equation from the dynamic stochastic general equilibrium dsge model with state dependent pricing developed by dotsey et al 1999 state dependent pricing and the general equilibrium dynamics of money and output quarterly journal of economics 114 655 690 this state dependent phillips curve encompasses the new keynesian phillips curve nkpc based on calvo type price setting as a special case we analyze the effect of the state dependent terms that is the variations in the distributions of price vintages on inflation persistence and we examine whether the hybrid nkpc that is the nkpc extended by a lagged inflation term can adequately describe inflation dynamics generated in a calibrated state dependent pricing economy

the inflation persistence of staggered contracts one of the criticisms routinely advanced against models with staggered contracts is their inability to generate inflation persistence this paper finds that staggered contracts a la taylor are in fact capable of reproducing the inflation persistence implied by u s data following fuhrer and moore i capture the moments that the model needs to replicate by using the correlograms from a small vector autoregression var i estimate the contract parameters using the method of maximum likelihood the correlogram of inflation for the contract model is very close to the correlogram from the var by the same metric taylor contracts fare poorly in reproducing the comovements of inflation and output

menu costs and phillips curves this paper develops a model of a monetary economy in which individual firms are subject to idiosyncratic productivity shocks as well as general inflation sellers can change price only by incurring a real menu cost we calibrate this cost and the variance and autocorrelation of the idiosyncratic shock using a new u s data set of individual prices due to klenow and kryvtsov the prediction of the calibrated model for the effects of high inflation on the frequency of price changes accords well with international evidence from various studies the model is also used to conduct numerical experiments on the economy s response to various shocks in none of the simulations we conducted did monetary shocks induce large or persistent real responses

selection and monetary non neutrality in time dependent pricing models for a given frequency of price adjustment monetary non neutrality is smaller if older prices are disproportionately more likely to change selection for the age of prices provides a complete characterization of price setting frictions in time dependent models selection for older prices is weaker and non neutralities are larger if the hazard function of price adjustment is less strongly increasing selection is weaker if there is heterogeneity in price stickiness finally selection is weaker if durations of price spells are more variable in particular the taylor 1979 model exhibits maximal selection for older prices whereas the calvo 1983 model exhibits no selection

stochastic inflation and the optimal policy of price adjustment this paper analyzes the optimal policy of price adjustment for a monopolistic firm in the presence of stochastic inflation it shows that an increase in the expected rate of inflation or in the cost of price adjustment leads to an increase in the initial real price and a decrease in the terminal real price in each period with a fixed nominal price it also shows that the effects of increased riskiness of inflation are ambiguous

sectoral and aggregate inflation dynamics in the euro area this paper synthesises the implications of recent statistical evidence regarding inflation persistence in the euro area for aggregate data the degree of inflation persistence appears to be very high for sample periods spanning multiple decades but falls dramatically once we allow for time variation in the mean level of inflation furthermore the timing of these breaks in mean generally coincides with observed shifts in the monetary policy regime finally sectoral inflation series exhibit much less persistence than aggregate inflation mainly because of the influence of transitory sector specific shocks jel e31 c22 c43

is inflation sticky abstract new keynesian sticky price models predict that monetary policy can affect real variables however they also predict that inflation can be reduced without depressing output or employment in fact bringing down inflation is costly presenting a challenge to the new keynesian model two departures from the new keynesian model predict costly disinflation one assumes sticky inflation rather than sticky prices while the other assumes less than perfectly rational expectations taking into account information from surveys of inflation expectations i find the evidence suggests that inflation is not sticky and that inflation expectations are less than perfectly rational

the un importance of forward looking behavior in price specifications the seminal work of edmund s phelps 1978 john b taylor 1980 and guillermo a calvo 1983 developed forward looking models of price determination that imparted inertia to the price level these models incorporate expectations of future prices and excess demand by imposing constraints typically lag lead symmetry constraints that force future variables to enter the specification in this paper the author tests the empirical significance of future prices in specifications like those of taylor he finds that expectations of future prices are empirically unimportant in explaining price and inflation behavior however the dynamics of a model that includes a purely backward looking inflation specification differ substantially and not altogether pleasingly from those with a forward looking specification copyright 1997 by ohio state university press

menu costs and the neutrality of money a model of endogenous price adjustment under money growth is presented firms follow s s pricing policies and price revisions are imperfectly synchronized in the aggregate price stickiness disappears and money is neutral the connection between firm price adjustment and relative price variability in the presence of monetary growth is also investigated the results contrast with those obtained in models with exogenous fixed timing of price adjustment

costs of price adjustment and the welfare economics of inflation and disinflation this paper studies the welfare consequences of inflation and disinflation in a model in which monopol istic firms incur a fixed cost of price adjustment it is shown that a moderately increasing price level is associated with higher social welfare than a perfectly stable price level and the model therefore provides theoretical support for the widespread belief that a little bit of inflation is good for the economy nevertheless it is also tr ue that the eradication of a moderate inflation leads to an increase in social welfare copyright 1988 by american economic association

calvo vs rotemberg in a trend inflation world an empirical investigation this paper estimates and compares new keynesian dsge monetary models of the business cycle derived under two dierent pricing schemes calvo 1983 and rotemberg 1982 under a positive trend in ation rate our empirical ndings i support trend in ation as an empirically relevant feature of the u s great moderation ii provide evidence in favor of the statistical superiority of the calvo setting iii support the absence of price indexation under the calvo mechanism only the superiority of the calvo model against rotemberg is due to the restrictions imposed by such a pricing scheme on the aggregate demand equation the determinacy regions implied by the two estimated models indicate relevant dierences in the implementable simple policy rules

intrinsic inflation persistence empirical evidence suggests that inflation determination is not purely forward looking but models of price setting have struggled to rationalize this finding without directly assuming backward looking pricing rules for firms this paper shows that intrinsic inflation persistence can be explained with no deviation from optimizing forward looking behaviour if prices that have remained fixed for longer are more likely to be changed than those set recently a relationship between the probability of price adjustment and the duration of a price spell is shown to imply a simple hybrid phillips curve including lagged and expected inflation which is estimated using macroeconomic data

interpreting inflation persistence comments on the conference on quantitative evidence on price determination the past decade has seen important advances in the analysis of price setting behavior most notably in my view a great deal of effort has been directed at the development of models that on the one hand have an explicit behavioral interpretation the models are clear about who sets prices what they seek to achieve when choosing prices and to what constraints they are subject when making the decision and at the same time can be parameterized so as to be compared in detail to inflation data this has allowed these models to be incorporated into complete dsge models of business fluctuations and of the monetary transmission mechanism that can be econometrically estimated this raises the prospect that it should soon be possible to base policy analysis on models that are both quantitatively realistic and plausibly invariant under the kinds of changes in policy that the analyst may wish to contemplate some argue that these two desiderata remain in considerable tension with one another that one cannot insist upon optimizing foundations at least under the current state of knowledge without substantial sacrifice of quantitative realism it is somewhat unfair however to present the quest for a model with optimizing foundations as a retreat from full insistence upon empirical realism given the fact that models with clear behavioral interpretations can be checked against a wider range of types of empirical evidence which should ultimately allow greater confidence in the realism of the specification that can withstand such scrutiny for example the exhaustive recent study of evidence on price setting in the euro area undertaken by the eurosystem s inflation persistence network compares alternative models in the light of three distinct

the output inflation trade off when prices are costly to change the output inflation trade off is investigated in a rational expectations equilibrium economy in which costly price setting makes it inefficient for agents to vary their prices at every instant it is shown that sticky prices are not some exogenous source of output fluctuation but result from the monetary policy process an economy with slow and counterinflationary money growth exhibits staggered changes in sticky prices as assumed in some new keynesian analyses an economy with fast money growth and a high degree of monetary accommodation exhibits either flexible prices or bunched frequently changing sticky prices

pricing decisions in an experimental dynamic stochastic general equilibrium economy we construct experimental economies populated with human subjects with a structure based on a nonlinear version of the new keynesian dynamic stochastic general equilibrium dsge model we analyze the behavior of firms pricing decisions in four different experimental economies we consider how well the experimental data conform to a number of accepted empirical stylized facts pricing patterns mostly conform to these patterns most price changes are positive and inflation is strongly correlated with average magnitude but not the frequency of price changes prices are affected negatively by the productivity shock and positively by the output gap lagged real interest rate has a negative effect on prices unless human subjects choose the interest rate or firms sell perfect substitutes in the output market there is inertia in price setting firms integrate wage increases into their prices and there is evidence of adaptive behavior in price setting in our laboratory economy the hazard function for price changes however is upward sloping in contrast to most empirical studies

a near rational model of the business cycle with wage and price inertia this paper presents a model in which insignificantly suboptimal behavior causes aggregate demand shocks to have significant real effects the individual loss to agents with inertial price wage behavior is second order in terms of the parameter describing the shock while the effect on real economic variables is first order thus significant changes in business activity can be generated by anticipated money supply changes provided that some agents are willing to engage in nonmaximizing behavior which results in small losses

borders and nominal exchange rates in risk sharing models of risk sharing predict that relative consumption growth rates are positively related to changes in real exchange rates we investigate this hypothesis using a new multicountry and multiregional data set within countries we find evidence for risk sharing episodes of high relative regional consumption growth are associated with regional real exchange rate depreciation across countries however the association is reversed relative consumption and real exchange rates are negatively correlated we define this reversal as a border effect we find the border effect and show that it accounts for over half of the deviations from full risk sharing since cross border real exchange rates involve different currencies it is natural to ask how much of the border effect is accounted for by movements in exchange rates our measures indicate that a large part of the border effect comes from nominal exchange rate fluctuations we develop a simple open economy model that is consistent with the importance of nominal exchange rate variability in accounting for deviations from cross country risk sharing

five facts about prices a reevaluation of menu cost models are price decreases 3 the frequency of price increases covaries strongly with inflation whereas the frequency of price decreases and the size of price increases and price decreases do not 4 the frequency of price change is highly seasonal it is highest in the first quarter and then declines 5 we find no evidence of upwardsloping hazard functions of price changes for individual products we show that the first second and third facts are consistent with a benchmark menu cost model whereas the fourth and fifth facts are not

intrinsic persistence of wage inflation in new keynesian models of the business cycles we derive and estimate a new keynesian wage phillips curve that accounts for intrinsic inertia in line with microevidence on wage setting we consider a wage setting model featuring an upward sloping hazard function based on the notion that the probability of resetting a wage depends on the time elapsed since the last reset our wage phillips curve embeds also backward terms we test the hazard function slope using generalized method of moment estimation then placing our equation in a small scale new keynesian model we investigate its dynamic properties using bayesian estimation model comparison shows that our model outperforms commonly used alternative methods to introduce persistence

pricing models a bayesian dsge approach for the u s economy this paper compares and estimates three pricing mechanisms in the context of a small dsge model of the u s economy we interpret our results as favoring the pricing mechanism presented in wolman 1999 wolman model over the new keynesian model with indexation gali and gertler 1999 smets and wouters 2004a and the sticky information model of mankiw and reis 2002 the key factor that explains the performance of the wolman model is that the data reject the key assumption of the new keynesian model that the firm s probability of price change is constant over time and independent of the contract s vintage our results also show that incorporating indexation in the new keynesian model represents a poor expedient in matching the autocorrelation function of the inflation process over the last 20 years

monopolistic competition and the effects of aggregate demand how important is monopolistic competition to an understanding of the effects of aggregate demand on output we ask the question at three levels can monopolistic competition by itself explain why aggregate demand movements affect output can it together with other imperfections generate effects of aggregate demand in a way that perfect competition cannot if so can it give an accurate account of the response of the economy to aggregate demand movements the answers are no yes and yes

staggered price contracts and inflation persistence some general results despite their popularity as theoretical tools for illustrating the effects of nominal rigidities some have questioned whether models based on staggered price contracts with rational expectations can match the persistence of the empirical inflation process this article presents some general results about this class of models it is shown that these models do not have a problem matching high autocorrelations for inflation however they fail to explain a key feature of reducedform phillips curve regressions the positive dependence of inflation on its own lags it is shown that staggered price contracting models instead predict that the coefficients on these lag terms should be negative

a dynamic economy with costly price adjustments this paper studies a general equilibrium model of a dynamic economy with menu costs each firm s productivity is exposed to idiosyncratic and aggregate productivity shocks around a trend and the money supply to monetary shocks around a trend all consumption pricing and production decisions are based on optimizing behavior there exists a staggered markov perfect equilibrium with prices determined by a two sided s s markup strategy the paper analyzes the optimal markup strategy and investigates the dynamics of the price index and the aggregate output the welfare consequences of the uncertain aggregate productivity and money supply are also examined

european inflation dynamics abstract we provide evidence on the fit of the new phillips curve npc for the euro area over the period 1970 1998 and use it as a tool to compare the characteristics of european inflation dynamics with those observed in the u s we also analyze the factors underlying inflation inertia by examining the cyclical behavior of marginal costs as well as that of its two main components namely labor productivity and real wages some of the findings can be summarized as follows a the npc fits euro area data very well possibly better than u s data b the degree of price stickiness implied by the estimates is substantial but in line with survey evidence and u s estimates c inflation dynamics in the euro area appear to have a stronger forward looking component i e less inertia than in the u s d labor market frictions as manifested in the behavior of the wage markup appear to have played a key role in shaping the behavior of marginal costs and consequently inflation in europe

the real effects of monetary shocks in sticky price models a sufficient statistic approach abstract we prove that the ratio of kurtosis to the frequency of price changes is a sufficient statistic for the real effects of monetary shocks measured by the cumulated output response following the shock the sufficient statistic result holds in a large class of models which includes taylor 1980 calvo 1983 reis 2006 golosov and lucas 2007 nakamura and steinsson 2010 midrigan 2011 and alvarez and lippi 2014 several models in this class are able to account for the positive excess kurtosis of the size distribution of price changes that appears in the data we review empirical measures of kurtosis and frequency and conclude that a model that successfully matches the microevidence on kurtosis and frequency produces real effects that are about four times larger than in the golosov lucas model and about 30 percent below those of the calvo model we discuss the robustness of our results to changes in the setup including small inflation and leptokurtic cost shocks jel e23 e31

search price setting and inflation a model of monopolistic competition in an inflationary environment is developed which embodies optimal sequential search price dynamics and entry on the part of consumers and firms respectively equilibrium price strategies are s s these bounds increase continuously with consumer search costs and so does price dispersion indeed the whole equilibrium varies smoothly from the competitive bertrand to the monopolistic diamond 1971 end of the spectrum the latter s paradoxical result is explained as a limiting case where frictions on firms side of the market price adjustment costs but not on buyers search costs tend to zero a positive relationship between smooth and perfectly anticipated inflation and price dispersion or uncertainty is established

optimal monetary policy optimal monetary policy maximizes the welfare of a representative agent given frictions in the economic environment constructing a model with two sets of frictions costly price adjustment by imperfectly competitive firms and costly exchange of wealth for goods we find optimal monetary policy is governed by two familiar principles first the average level of the nominal interest rate should be sufficiently low as suggested by milton friedman that there should be deflation on average yet the keynesian frictions imply that the optimal nominal interest rate is positive second as various shocks occur to the real and monetary sectors the price level should be largely stabilized as suggested by irving fisher albeit around a deflationary trend path since expected inflation is roughly constant through time the nominal interest rate must therefore vary with the fisherian determinants of the real interest rate although the monetary authority has substantial leverage over real activity in our model economy it chooses real allocations that closely resemble those which would occur if prices were flexible in our benchmark model there is some tendency for the monetary authority to smooth nominal and real interest rates

new tests of the new keynesian phillips curve abstract lagged dependent variables typically play an important role in empirical models of inflation do these lags reflect backward looking inflation expectations or do they proxy for rational forward looking expectations as in the new keynesian phillips curve gali and gertler 1999 inflation dynamics a structural econometric analysis journal of monetary economics 44 195 222 attempt to answer this question using gmm to estimate specifications incorporating both lagged and future inflation they report small coefficients on lagged inflation and conclude that the new keynesian model provides a good first approximation to inflation dynamics we show that these tests have low power against alternative backward looking specifications and demonstrate that their results are also consistent with a backward looking phillips curve using an alternative approach we find that the new keynesian pricing model cannot explain the importance of lagged inflation in standard inflation regressions and find that forward looking terms play a very limited role in explaining inflation dynamics

state dependent pricing and the general equilibrium dynamics of money and output economists have long suggested that nominal product prices are changed infrequently because of fixed costs in such a setting optimal price adjustment should depend on the state of the economy yet while widely discussed statedependent pricing has proved difficult to incorporate into macroeconomic models this paper develops a new tractable theoretical state dependent pricing framework we use it to study how optimal pricing depends on the persistence of monetary shocks the elasticities of labor supply and goods demand and the interest sensitivity of money demand