"Microfoundations of Inflation Persistence in the New Keynesian Phillips Curve", by Marcelle Chauvet (Professor of Economics; Chair, Latin American Studies Program, University of California, Riverside).
This paper proposes a dynamic stochastic general equilibrium model that endogenously generates inflation persistence. We assume that although firms change prices periodically, they face convex managerial and customer costs that preclude complete adjustment. In essence, the model assumes that price stickiness arises from both the frequency and size of price adjustments. The model is estimated using Bayesian techniques and the results strongly support both sources of price stickiness in the U.S. data. The model performs very well in matching the distribution of micro price changes, in particular large and small price changes. This
paper also shows how incomplete price adjustments in a staggered price contracts model limit the contribution of expectations to inflation dynamics and generate the delayed response of inflation to demand and monetary shocks, as well the observed “reverse dynamic” correlation between inflation and economic activity.
Sponsored by the Economics Department Danforth-Lewis Speakers Series.
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