Time-Varying Business Volatility, Price Setting, and the Real Effects of Monetary Policy

Ruediger Bachmann, Benjamin Born, Steffen Elstner, Christian Grimme

NBER Working Paper No. 19180
Issued in June 2013
NBER Program(s):   EFG   ME

Does time-varying business volatility affect the price setting of firms and thus the transmission of monetary policy into the real economy? To address this question, we estimate from the firm-level micro data of the German IFO Business Climate Survey the impact of idiosyncratic volatility on the price setting behavior of firms. In a second step, we use a calibrated New Keynesian business cycle model to gauge the effects of time-varying volatility on the transmission of monetary policy to output. Our results are twofold. Heightened business volatility increases the probability of a price change, though the effect is small: the tripling of volatility during the recession of 08/09 caused the average quarterly likelihood of a price change to increase from 31.6% to 32.3%. Second, the effects of this increase in volatility on monetary policy are also small; the initial effect of a 25 basis point monetary policy shock to output declines from 0.347% to 0.341%.

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Document Object Identifier (DOI): 10.3386/w19180

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