State-dependent pricing turns money into a two-edged sword: A new role for monetary policy. (December 2021)

• Record Type: Journal Article
• Authors: Le, Vo Phuong Mai; Meenagh, David; Minford, Patrick
• Is Part Of: Journal of international money and finance. Volume 119(2022)
• Publication Date: 2021-12
• Subjects: State-dependence -- New Keynesian -- Rational Expectations -- Crises -- Price Stability -- Nominal GDP; E2 -- E3; International finance -- Periodicals; Foreign exchange -- Periodicals; Finances internationales -- Périodiques; Change -- Périodiques; Foreign exchange; International finance; Periodicals; 332.04205
• DOI: 10.1016/j.jimonfin.2021.102496
• Languages: English
• ISSNs: 0261-5606

Abstract

Highlights: State-dependence in pricing is embedded into a model of the US. Reintroducing a degree of 'classical' contingent-contract behaviour to macro models. This allows the model to match the data behaviour of the whole post-war period. Monetary policy controls inflation and now determines the economy's price stickiness. A nominal GDP targeting rule, with fiscal policy to prevent ZLB, reduces crises. Abstract: Strong evidence exists that price/wage durations are dependent on the state of the economy, especially inflation. We embed this dependence in a macro model of the US that otherwise does well in matching the economy's behaviour in the last three decades; it now also matches it over the whole post-war period. This finding implies a major new role for monetary policy: besides controlling inflation it now determines the economy's price stickiness. We find that, when backed by fiscal policy in preventing a ZLB, by targeting nominal GDP monetary policy can achieve high price stability and avoid large cyclical output fluctuations.