Monetary Policy, Inflation Expectations and the Price Puzzle

38 Pages Posted: 28 Nov 2009

See all articles by Efrem Castelnuovo

Efrem Castelnuovo

University of Padua - Department of Economics

Paolo Surico

London Business School - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: November 25, 2009

Abstract

This paper re-examines the VAR evidence on the price puzzle and proposes a new theoretical interpretation. Using actual data and two identification strategies based on zero restrictions and model-consistent sign restrictions, we find that the positive response of prices to a monetary policy shock is historically limited to the sub-samples that are typically associated with a weak interest rate response to inflation. Using pseudo data generated by a sticky price model of the US economy, we then show that the structural VARs are capable of reproducing the price puzzle only when monetary policy is passive. The omission in the VARs of a variable capturing expected inflation is found to account for the price puzzle observed in simulated and actual data.

Keywords: SVARs, price puzzle, sticky price model, Taylor principle, passive policy

JEL Classification: E30, E52

Suggested Citation

Castelnuovo, Efrem and Surico, Paolo, Monetary Policy, Inflation Expectations and the Price Puzzle (November 25, 2009). Bank of Finland Research Discussion Paper No. 30/2009, Available at SSRN: https://ssrn.com/abstract=1513241 or http://dx.doi.org/10.2139/ssrn.1513241

Efrem Castelnuovo (Contact Author)

University of Padua - Department of Economics ( email )

via Del Santo 33
Padova, 35123
Italy

Paolo Surico

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

HOME PAGE: http://sites.google.com/site/paolosurico

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

HOME PAGE: http://sites.google.com/site/paolosurico

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