Sticky Price and Limited Participation Models of Money: A Comparison

58 Pages Posted: 20 Jan 1997 Last revised: 12 Nov 2022

See all articles by Lawrence J. Christiano

Lawrence J. Christiano

Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)

Martin Eichenbaum

Northwestern University; National Bureau of Economic Research (NBER)

Charles L. Evans

Federal Reserve Bank of Chicago - Research Department

Date Written: October 1996

Abstract

This paper provides new evidence that models of the monetary transmission mechanism should be consistent with at least the following facts. In response to a contractionary monetary policy shock, the aggregate price level responds very little, aggregate output falls, interest rates initially rise, real wages decline, though by a modest amount, and profits fall. The paper argues that neither sticky price nor limited participation models can convincingly account for these facts. The key failing of the sticky price model is that it implies profits rise after a contractionary monetary policy shock. This finding is robust to a variety of perturbations of the benchmark sticky price model that we consider. In contrast, the limited participation model can account for all of the facts mentioned above. But it can do so only if one is willing to assume a high labor supply elasticity (2) and a high average markup (40%). The shortcomings of both models reflect the absence of other frictions, such as wage contracts, which dampen movements in the marginal cost of production after a monetary policy shock.

Suggested Citation

Christiano, Lawrence J. and Eichenbaum, Martin and Evans, Charles L., Sticky Price and Limited Participation Models of Money: A Comparison (October 1996). NBER Working Paper No. w5804, Available at SSRN: https://ssrn.com/abstract=3715

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