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Inflation, Output, and Markup Dynamics with Forward-Looking Wage and Price Setters

Louis Phaneuf, Eric R. Sims, Jean Gardy Victor

NBER Working Paper No. 21599
Issued in September 2015
NBER Program(s):The Economic Fluctuations and Growth Program, The Monetary Economics Program

We formulate a medium-scale DSGE model that emphasizes a strong interplay between a roundabout production structure and a working capital channel that requires firms to borrow funds to finance the costs of all their variable inputs and not just the wage bill. Despite an absence of backward-looking price and wage indexation, our model is able to account for (i) a persistent and hump-shaped response of inflation to a monetary policy shock, (ii) a large and persistent response of output to a monetary policy shock, (iii) a mild "price puzzle," (iv) a procyclical price markup conditional on a monetary shock, (v) non-inertial responses of inflation to non-monetary shocks, and (vi) a negative unconditional autocorrelation of the first difference of inflation that is consistent with the data. A medium-scale model relying on backward indexation of wages and prices to past inflation fails along several of these dimensions.

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Document Object Identifier (DOI): 10.3386/w21599

Published: Louis Phaneuf & Eric Sims & Jean Gardy Victor, 2018. "Inflation, Output and Markup Dynamics with Purely Forward-Looking Wage and Price Setters," European Economic Review, .

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