Are State and Time Dependent Models Really Different?
Yes, but only for large monetary shocks. In particular, we show that in a broad class of models where shocks have continuous paths, the propagation of a monetary impulse is independent of the nature of the sticky price friction when shocks are small. The propagation of large shocks instead depends on the nature of the friction: the impulse response of inflation to monetary shocks is independent of the shock size in time-dependent models, while it is non-linear in state-dependent models. We use data on exchange rate devaluations and inflation for a panel of countries over 1974-2014 to test for the presence of state dependent decision rules. We present some evidence of a non-linear effect of exchange rate changes on prices in a sample of flexible-exchange rate countries with low inflation. We discuss the dimensions in which this finding is robust and the ones in which it is not.
Document Object Identifier (DOI): 10.3386/w22361
Published: Are State- and Time-Dependent Models Really Different?, Fernando Alvarez, Francesco Lippi, Juan Passadore. in NBER Macroeconomics Annual 2016, Volume 31, Eichenbaum and Parker. 2017
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