Inflation and Output Dynamics in a Model with Labor Market Search and Capital Accumulation
34 Pages Posted: 2 Jul 2007
Date Written: June 2007
In a sticky-price model with labor market search and habit persistence, Walsh (2005) shows that inertia in the interest rate policy helps to reconcile the inflation and output persistence with empirical observations for the US economy. We show that this finding is sensitive with regard to the introduction of capital formation. While we are able to replicate the findings for the inflation inertia in a model with capital adjustment costs and variable capacity utilization, the output response to an interest shock is found to be too large and no longer hump-shaped in this case. In addition we find that the response of output to a technology shock can only be reconciled with empirical findings if either the adjustment of the utilization rate is very costly or there is only a modest amount of nominal rigidity in the economy.
Keywords: interest rate policy, labor market search, business cycles, inflation, capital adjustment costs
JEL Classification: E52, E32, J64
Suggested Citation: Suggested Citation