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Are State- and Time-Dependent Models Really Different?

Fernando Alvarez, Francesco Lippi and Juan Passadore

NBER Macroeconomics Annual, 2017, vol. 31, issue 1, 379 - 457

Abstract: Yes, state- and time-dependent models are really different, but only for large monetary shocks. In particular, we show that in a broad class of models where shocks have continuous paths, the propagation of a monetary impulse is independent of the nature of the sticky price friction when shocks are small. The propagation of large shocks instead depends on the nature of the friction: the impulse response of inflation to monetary shocks is independent of the shock size in time-dependent models, while it is nonlinear in state-dependent models. We use data on exchange rate devaluations and inflation for a panel of countries from 1974 to 2014 to test for the presence of state-dependent decision rules. We present some evidence of a nonlinear effect of exchange rate changes on prices in a sample of flexible exchange rate countries with low inflation. We discuss the dimensions in which this finding is robust and the ones in which it is not.

Date: 2017
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Chapter: Are State- and Time-Dependent Models Really Different? (2016)
Working Paper: Are State and Time dependent models really different? (2016) Downloads
Working Paper: Are State and Time Dependent Models Really Different? (2016) Downloads
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