Sticky prices and the transmission mechanism of monetary policy: A minimal test of New Keynesian models

Mar 2019 | 869

Authors: Guido Ascari Timo Haber

This paper proposes a minimal test of two basic empirical predictions that ag-gregate data should exhibit if sticky prices were the key transmission mechanism of monetary policy, as implied by the benchmark DSGE-New Keynesian models. First, large monetary policy shocks should yield proportionally larger initial re-sponses of the price level and smaller real effects on output. Second, in a high trend inflation regime, prices should be more flexible, and thus the real effects of monetary policy shocks should be smaller and the response of the price level larger. Our analysis provides some statistically significant evidence in favor of a sticky price theory of the transmission mechanism of monetary policy shocks.

JEL Codes: E30, E52, C22

Keywords: Sticky prices, local projections, smooth transition function, time-dependent pricing, state-dependent pricing

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