Staff Report 217

Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?

Ellen R. McGrattan Consultant
Patrick J. Kehoe Consultant
V. V. Chari Consultant

Revised May 1, 1998

We construct a quantitative equilibrium model with price setting and use it to ask whether with staggered price setting monetary shocks can generate business cycle fluctuations. These fluctuations include persistent output fluctuations along with the other defining features of business cycles, like volatile investment and smooth consumption. We assume that prices are exogenously sticky for a short period of time. Persistent output fluctuations require endogenous price stickiness in the sense that firms choose not to change prices very much when they can do so. We find that for a wide range of parameter values the amount of endogenous stickiness is small. As a result, we find that in a standard quantitative business cycle model staggered price setting, by itself, does not generate business cycle fluctuations.

Published In: Econometrica (Vol. 68, No. 5, September 2000, pp. 1151-79)

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