State-dependent pricing turns money into a two-edged sword: A new role for monetary policy

•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 pr...

Full description

Saved in:
Bibliographic Details
Published inJournal of international money and finance Vol. 119; p. 102496
Main Authors Le, Vo Phuong Mai, Meenagh, David, Minford, Patrick
Format Journal Article
LanguageEnglish
Published Elsevier Ltd 01.12.2021
Subjects
Crises
New Keynesian
Nominal GDP
Price Stability
Rational Expectations
State-dependence
State-dependence
Rational Expectations
Nominal GDP
New Keynesian
Price Stability
Crises
E2
E3
Online AccessGet full text

Cover

More Information
Summary:•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. 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.
ISSN:0261-5606
1873-0639
DOI:10.1016/j.jimonfin.2021.102496