presentation bey ballesta, eskandari

8/9/2019 Presentation bey Ballesta, Eskandari

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Staggered price setting and

persistence

Monetary Policy IDEA

Daniel AhelegbeyBlanca BallestaRuhollah Eskandari


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Introduction

Data evidence

monetary policy shocks have a delayed butPERSISTENT effect on output

Problem!

Most of the models (Lucas Islands, CIA, rigidityon wages) dont reproduce this feature of thedata: effects on output but not persistent.


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Aggregate static demand for money

If we want a large effect on output, it must bewe have rather small effect on prices

Persistence problem

Can staggered price setting solve the persistenceproblem??


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Staggered price setting


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Let price set up by firm at period t (that willbe the same for period t+1). Hence

Money supply shock

Strong propagation mechanism!!!


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The model

Assumptions

Price setting

Aggregate demand

Linear labor supply

Money as a random walk


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An intermediate goods sector, where a continuum ofmonopolists set the price on their unique intermediategood. With production function:

Goods sector operating under perfect competition, using

intermediate goods as inputs. They maximize profits:

The economy has two sectors:


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Profit maximization

After some manipulation of the FOC and making a Taylorsapproximation one can get:

Substituting the Price setting


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Consumers problem In the particular framework of our homework, the

supply of labor is determined by the tastes of workers incompetitive labor markets, hence workers decide their

labor supply typically maximize their utility functionsubject to their budget constraint.

Since there is no capital


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Therefore the consumer problem becomes

FOC

Including that

Considering that we assumed real marginal costs linearlyrelated to output

where

Labor supply elasticity (exogenously given)

Weight of leisure time in the utility function (structural parameter)


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After some manipulation of the FOC and making aTaylors approximation one can get:

Substituting the real marginal cost

Substituting the aggregate demand function


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Therefore


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Since nominal money supply follows a random walk

given by

Assuming ptfollows a linear pattern given by

The firm will set up the price according to weighted sum of both, theprice the other type of firms set up yesterday for today the monetarybase.

where a+b = 1


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forwards

Ifa is high (lower b) then a monetary shock will not be transformed(will have little effect) on an increase on expected prices for

tomorrow and therefore the prices will not be much affected today.The shock will have real effects during more time since prices adaptslowly and hence the persistence of will be longer.

If b is high (lower a) then prices adapt quickly and stronger tomonetary shocks, hence the shock will not lead to a persistent realeffect on output.


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We can solve for a and b

Therefore

becomes


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Solving for a


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Substituting

The solution to the problem is

The associated solution for aggregate prices is


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Since

then,

After money supply shock prices in period t will reactstrongly. Hence, an increase in money will not lead to apersistent real effect on output.

Price stickyness is still not enough to get rid of thepersistent problem!!!


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One last result

One can see that

The higher the parameter (the more consumers valueleisure) the lower the parameter awhich implies lesspersistency of the monetary shocks in the real variable.

If consumer put less value on leisure time and only careabout consumption then the prices will react slowly tothe monetary shocks and therefore there will be moreplace for an effective monetary policy.


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Summarizing


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Thanks!

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