Sticky Prices Versus Monetary Frictions: An Estimation of Policy Trade-Offs

56 Pages Posted: 13 Apr 2009 Last revised: 20 Aug 2010

See all articles by S. Borağan Aruoba

S. Borağan Aruoba

University of Maryland - Department of Economics

Frank Schorfheide

University of Pennsylvania - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); University of Pennsylvania - The Penn Institute for Economic Research (PIER)

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Date Written: April 2009

Abstract

We develop a two-sector monetary model with a centralized and decentralized market. Activities in the centralized market resemble those in a standard New Keynesian economy with price rigidities. In the decentralized market agents engage in bilateral exchanges for which money is essential. The model is estimated and evaluated based on postwar U.S. data. We document its money demand properties and determine the optimal long-run inflation rate that trades off the New Keynesian distortion against the distortion caused by taxing money and hence transactions in the decentralized market. Target rates of -1% or less maximize the social welfare function we consider, which contrasts with results derived from a cashless New Keynesian model.

Suggested Citation

Aruoba, S. Boragan and Schorfheide, Frank, Sticky Prices Versus Monetary Frictions: An Estimation of Policy Trade-Offs (April 2009). NBER Working Paper No. w14870, Available at SSRN: https://ssrn.com/abstract=1376192

S. Boragan Aruoba (Contact Author)

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States
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Frank Schorfheide

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
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Philadelphia, PA 19104-6297
United States

HOME PAGE: http://www.econ.upenn.edu/~schorf

Centre for Economic Policy Research (CEPR)

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United Kingdom

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

University of Pennsylvania - The Penn Institute for Economic Research (PIER) ( email )

Philadelphia, PA
United States

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