Kiel Working Papers, Kiel Institute for World Economics
No 1361:
Basic Calvo and P-Bar Models of Price Adjustment: A Comparison
Bennett T. McCallum
Abstract: It is clear that at present various versions of the Calvo
(1983) model of price adjustment are dominant in monetary policy
analysis—see, e.g., Woodford (2003). This is true despite well-known
criticisms including Mankiw (2001) or Mankiw and Reis (2002) and the
well-documented need for the addition of ad-hoc features if actual
inflation and output data are to be matched. Accordingly, there is ample
reason, to give consideration to alternative models. In this paper, a new
look is given to the P-bar model utilized by McCallum and Nelson (1999a,
1999b), based on previous work by Mussa (1981) and others. Relative to the
Calvo model, the P-bar specification has three significant advantages: it
satisfies the strict version of the natural rate hypothesis; it relies on
costs of adjusting output, which are more tangible than menu costs of
changing prices; and its basic version produces more realistic
autocorrelation patterns than does the basic Calvo specification. The
present paper develops these comparisons more completely and systematically
than in previous work.
31 pages, June 2007
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