Sticky price and limited participation models of money: A comparison

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

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

207 Scopus citations

Abstract

We provide new evidence that models of the monetary transmission mechanism should be consistent with at least the following facts. After a contractionary monetary policy shock, the aggregate price level responds very little, aggregate output falls, interest rates initially rise, real wages decline by a modest amount, and profits fall. We compare the ability of sticky price and limited participation models with frictionless labor markets to account for these facts. The key failing of the sticky price model lies in its counterfactual implications for profits. The limited participation model can account for all the above facts, but only if one is willing to assume a high labor supply elasticity (2 percent) and a high markup (40 percent). The shortcomings of both models reflect the absence of labor market frictions, such as wage contracts or factor hoarding, which dampen movements in the marginal cost of production after a monetary policy shock.

Original languageEnglish (US)
Pages (from-to)1201-1249
Number of pages49
JournalEuropean Economic Review
Volume41
Issue number6
DOIs
StatePublished - Jun 1997

Keywords

  • Credit
  • Mechanism
  • Monetary transmission
  • Prices

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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