Reconsideration of the P-Bar Model of Gradual Price Adjustment

33 Pages Posted: 16 Jul 2008 Last revised: 14 Sep 2010

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Date Written: July 2008

Abstract

This paper compares the P-bar model of price adjustment with the currently dominant Calvo specification. Theoretically, the P-bar model is more attractive as it depends upon adjustment costs for physical quantities rather than nominal prices, while incorporating a one-period information lag. Furthermore, the resulting adjustment relation is more completely free of "money illusion," in terms of dynamic relationships, and therefore satisfies the natural rate hypothesis of Lucas (1972), which is not satisfied by the Calvo model in any of its variants. Along the way, it shows that both the P-bar and Calvo models can be formulated in distinct versions in which current real wages are, or are not, allocative. Quantitatively, for a given calibration of the demand parameters, the implied time series properties of the inflation rate, output gap, and nominal interest rate are determined for various policy parameters, and are compared with quarterly data for the U.S. economy. Neither model dominates but, overall, the comparison seems somewhat more favorable to the P-bar model and certainly does not provide support for the dominant position held by the Calvo model in current monetary policy analysis.

Suggested Citation

McCallum, Bennett T., Reconsideration of the P-Bar Model of Gradual Price Adjustment (July 2008). NBER Working Paper No. w14163, Available at SSRN: https://ssrn.com/abstract=1161086

Bennett T. McCallum (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-2347 (Phone)
412-268-7357 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
8
Abstract Views
315
PlumX Metrics