The Price Puzzle and Indeterminacy

Efrem Castelnuovo and Paolo Surico

Macroeconomics from University Library of Munich, Germany

Abstract: This paper re-examines the empirical evidence on the price puzzle and proposes a new theoretical interpretation. Using structural VARs and two different identification strategies based on zero restrictions and sign restrictions, we find that the positive response of price to a monetary policy shock is historically limited to the sub-samples associated with a weak central bank response to inflation. These sub-samples correspond to the pre-Volcker period for the US and the pre-inflation targeting regime for the UK. Using a micro-founded DSGE sticky price model of the US economy, we then show that the structural VARs are capable of reproducing the price puzzle on artificial data only when monetary policy is passive and hence multiple equilibria arise. In contrast, the DSGE model never generates on impact a positive inflation response to a policy shock. The omission in the VARs of a variable capturing the high persistence of expected inflation under indeterminacy is found to account for the price puzzle observed on actual data.

Keywords: Price puzzle; DSGE model; Taylor principle; Indeterminacy; SVARs (search for similar items in EconPapers)
JEL-codes: E30 E52 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2005-07-20
New Economics Papers: this item is included in nep-mac and nep-mon
Note: Type of Document - pdf; pages: 36
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpma:0507021

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