Temporary Price Changes and the Real Effects of Monetary Policy

Posted: 8 Oct 2008

See all articles by Patrick J. Kehoe

Patrick J. Kehoe

Federal Reserve Bank of Minneapolis - Research Department; University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)

Virgiliu Midrigan

Ohio State University (OSU) - Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2008

Abstract

In the data, prices change both temporarily and permanently. Standard Calvo models focus on permanent price changes and take one of two shortcuts when confronted with the data: drop temporary changes from the data or leave them in and treat them as permanent. We provide a menu cost model that includes motives for both types of price changes. Since this model accounts for the main regularities of price changes, its predictions for the real effects of monetary policy shocks are useful benchmarks against which to judge existing shortcuts. We find that neither shortcut comes close to these benchmarks. For monetary policy analysis, researchers should use a menu cost model like ours or at least a third, theory-based shortcut: set the Calvo model's parameters so that it generates the same real effects from monetary shocks as does the bench-mark menu cost model. Following either suggestion will improve monetary policy analysis.

Keywords: Sticky prices, sales, menu costs, Calvo model, New Keynesian model

JEL Classification: E31, E32, E52

Suggested Citation

Kehoe, Patrick J. and Midrigan, Virgiliu, Temporary Price Changes and the Real Effects of Monetary Policy (September 1, 2008). Available at SSRN: https://ssrn.com/abstract=1280910

Patrick J. Kehoe (Contact Author)

Federal Reserve Bank of Minneapolis - Research Department ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States
612-204-5525 (Phone)
612-204-5515 (Fax)

University of Minnesota - Twin Cities - Department of Economics ( email )

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Minneapolis, MN 55455
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Virgiliu Midrigan

Ohio State University (OSU) - Economics ( email )

410 Arps Hall
1945 N. High St.
Columbus, OH 43210-1172
United States

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