The Cost of Nominal Inertia in Nns Models

51 Pages Posted: 22 Nov 2004

See all articles by Matthew B. Canzoneri

Matthew B. Canzoneri

Georgetown University

Robert E. Cumby

Georgetown University - Department of Economics; National Bureau of Economic Research (NBER)

Behzad Diba

Georgetown University

Date Written: November 2004

Abstract

We calculate the welfare cost of nominal inertia in a New Neoclassical Synthesis model with wage and price stickiness, capital formation, and empirically estimated rules for government spending and the cental bank's interest rate policy. We calibrate our model to U.S. data, and we show that it captures many aspects of the U.S. business cycle. Moreover, our model is capable of generating the kind of volatility that has been observed in the efficiency gaps emphasized by Erceg, Henderson and Levin (2000) and Gali, Gertler and Lopez-Salido (2002). We also highlight some of the empirical shortcomings of the model; in particular, demand side shocks appear to be either missing or improperly modeled. We calculate the cost of nominal inertia under two specifications of monetary policy. The bottom line is that, under our preferred specification of monetary policy, the model implies a conservative estimate of the cost that is twenty to sixty times larger than Lucas's (2003) estimate: the "average" household in our model would be willing to give up one to three percent of consumption each period to be free of the effects of wage and price stickiness. Wage inertia appears to be the major source of these welfare costs.

Suggested Citation

Canzoneri, Matthew B. and Cumby, Robert E. and Diba, Bezhad, The Cost of Nominal Inertia in Nns Models (November 2004). NBER Working Paper No. w10889. Available at SSRN: https://ssrn.com/abstract=618571

Matthew B. Canzoneri

Georgetown University ( email )

Washington, DC 20057
United States
202-687-5911 (Phone)
202-687-6102 (Fax)

Robert E. Cumby (Contact Author)

Georgetown University - Department of Economics ( email )

580 Intercultural Center
Washington, DC 20057
United States
202-687-2990 (Phone)
202-687-6102 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Bezhad Diba

Georgetown University ( email )

Washington, DC 20057
United States
2026875682 (Phone)
2026876102 (Fax)

HOME PAGE: http://econ.georgetown.edu/

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