Sticky Price and Limited Participation Models of Money: A Comparison

Lawrence J. Christiano, Martin Eichenbaum, Charles L. Evans

NBER Working Paper No. 5804
Issued in October 1996
NBER Program(s):Economic Fluctuations and Growth, Monetary Economics

This paper provides new evidence that models of the monetary transmission mechanism should be consistent with at least the following facts. In response to a contractionary monetary policy shock, the aggregate price level responds very little, aggregate output falls, interest rates initially rise, real wages decline, though by a modest amount, and profits fall. The paper argues that neither sticky price nor limited participation models can convincingly account for these facts. The key failing of the sticky price model is that it implies profits rise after a contractionary monetary policy shock. This finding is robust to a variety of perturbations of the benchmark sticky price model that we consider. In contrast, the limited participation model can account for all of the facts mentioned above. But it can do so only if one is willing to assume a high labor supply elasticity (2) and a high average markup (40%). The shortcomings of both models reflect the absence of other frictions, such as wage contracts, which dampen movements in the marginal cost of production after a monetary policy shock.

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Document Object Identifier (DOI): 10.3386/w5804

Published: Christiano, Lawrence J., Martin Eichenbaum and Charles L. Evans. "Sticky Price And Limited Participation Models Of Money: A Comparison," European Economic Review, 1997, v41(6,Jun), 1201-1249. citation courtesy of

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