Temporary Price Changes and the Real Effects of Monetary Policy

51 Pages Posted: 10 Oct 2008 Last revised: 13 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 Midrigin

New York University (NYU) - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: October 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 benchmark menu cost model. Following either suggestion will improve monetary policy analysis.

Suggested Citation

Kehoe, Patrick J. and Midrigin, Virgiliu, Temporary Price Changes and the Real Effects of Monetary Policy (October 2008). NBER Working Paper No. w14392. Available at SSRN: https://ssrn.com/abstract=1281884

Patrick J. Kehoe (Contact Author)

Federal Reserve Bank of Minneapolis - Research Department ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
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612-204-5525 (Phone)
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University of Minnesota - Twin Cities - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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Virgiliu Midrigin

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States

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