This paper reexamines wage and price dynamics in response to permanent shocks to productivity. We estimate a micro-founded dynamic general equilibrium (DGE) model of the U.S. economy with sticky wages and sticky prices using impulse responses to technology and monetary policy shocks. We utilize a flexible specification for wageand price-setting that allows for the sluggish adjustment of both the levels of these variables—as in standard contracting models—as well as intrinsic inertia in wage and price inflation. On the price front, we find that in our VAR inflation jumps in response to an identified permanent technology shock, implying that, on average, prices adjust quickly and that there is little evidence for any intrinsic inflation inertia like that commonly found in models used for monetary policy evaluation. On the wage front, we find evidence for significant inertia in wages and some intrinsic inertia in nominal wage inflation. Our results provide support for the standard sticky-price specification of the New Keynesian model; however, the evidence on the high degree of wage inertia presents a challenge for standard models of wage setting.

NOTE: International Finance Discussion Papers are preliminary materials circulated to stimulate discussion and critical comment. References in publications to International Finance Discussion Papers (other than an acknowledgement that the writer has had access to unpublished material) should be cleared with the author or authors. Recent IFDPs are available on the Web at www.federalreserve.gov/pubs/ifdp/.The Inflation Persistence of Staggered Contracts

A persistent criticism of general equilibrium models of monetary policy which incorporate nominal inertia in the form of the New Keynesian Phillips Curve (NKPC) is that they fail to capture the extent of inflation inertia in the data. In this paper we derive a general equilibrium model based on optimising behaviour, but which also implies a data consistent NKPC. Specifically our model accounts for nominal inertia in both price and wage setting as well for habits in consumption. Using US and European data from 1970 to 1998 our parameter estimates reveal that (i) there is relatively more inertia in price and wage-setting in Europe; (ii) the extent of backward-looking behaviour in price setting is statistically significant in both economies, but backward-looking wage-setting is only present in Europe; and (iii) similar habits effects are present in both European and US consumption. Finally we simulate the effects of monetary policy and find that our parameter estimates imply significant differences in the responses to monetary policy between the two economies.

This paper argues that Blinder undertakes a questionnaire study to investigate the reasons why prices are sticky. In order to do this he assesses the relevance of various neoclassical theories to the thinking of business executives. We argue that in spite of his intentions Blinder's interpretation of his results is methodologically flawed and that the inductive findings of the research support post Keynesian pricing theory. Having 24

This paper attempts to reconcile Gordon and Sargent's disparate observations using a single theoretical model of inflation and disinflation. The model's key feature, a fixed cost of price adjustment, makes firms unwilling to immediately reset their nominal prices following a small change in inflation. Most of the disinflationary episodes studied by Gordon began from moderate rates of inflation, and indeed, the end of a small inflation in the model presented here is accompanied by losses in aggregate output, although these losses are minimized when the disinflation is gradual. At the same time, however, firms incur the fixed cost to adjust their prices following a large change in inflation; big inflations, like those studied by Sargent, can be eliminated quickly with no loss in aggregate output. Parts of this story appear elsewhere. Ball, Mankiw, and Romer (1988), for instance, develop a model of costly price adjustment in which monetary shocks have larger effects on output at lower rates of inflation; the real effects of money tend to vanish as inflation rises. Because of the technical difficulties associated with solving models featuring fixed costs of price adjustment, however, previous studies have been unable to consider the full effects of large changes in policy, such as those required to implement a disinflation. Danziger (1988), for example, addresses the problem of disinflation in a model of costly price adjustment, but confines his analysis to cases in which a small inflation is brought immediately to an end. He therefore stops short of answering the questions considered here: how does the cost of disinflation depend on the initial inflation rate, and how does it depend on the speed of disinflation? Other studies of disinflation, including Phelps (1979), Tay...

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central banks do? ” It subsequently evolved into the background paper for my Queen’s Prize Lecture at the London School of Economics, 19 May 2003, titled “Deflation: Causes, Prevention and Cure”. I would like to thank Anne Sibert for helpful comments and Toshiaki Sakatsume for able research assistance. The views and opinions expressed are those of the author. They do not necessarily represent the views and opinions of the European Bank for Reconstruction and Development. ©Willem H. Buiter, 2003. After an absence of almost half a century, the spectre of deflation is once again haunting the corridors of central banks and finance ministries in the industrial world. While preventing or combating deflation poses some unique difficulties not present in preventing or combating inflation, deflation can be prevented and, if it has taken hold, can be overcome, using conventional instruments of monetary and fiscal policy. These include open market purchases of government securities and monetary financing of government

variance, commodity price skewness. We would like to thank Jon Temple, the editor and two anonymous referees of this journal for very helpful comments on an earlier version. Remaining errors are our own.

In 2006 all ECB publications will feature a motif taken from the €5 banknote. This paper can be downloaded without charge from

In 2005 all ECB publications will feature a motif taken from the €50 banknote. This paper can be downloaded without charge from