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Title:The cost of tractability and the Calvo pricing assumption PDF Logo
Authors:Yao, Fang
Issue Date:2009
Series/Report no.:SFB 649 discussion paper 2009,042
Abstract:This paper demonstrates that tractability gained from the Calvo pricing assumption is costly in terms of aggregate dynamics. I derive a generalized New Keynesian Phillips curve featuring a generalized hazard function, non-zero steady state inflation and real rigidity. Analytically, I find that important dynamics in the NKPC are canceled out due to the restrictive Calvo assumption. I also present a general result, showing that, under certain conditions, this generalized Calvo pricing model generates the same aggregate dynamics as the generalized Taylor model with heterogeneous price durations. The richer dynamic structure introduced by the non-constant hazards is also quantitatively important to the inflation dynamics. Incorporation of real rigidity and trend inflation strengthen this effect even further. With reasonable parameter values, the model accounts for hump-shaped impulse responses of inflation to the monetary shock, and the real effects of monetary shocks are 2-3 times higher than those in the Calvo model.
Subjects:Hazard function
nominal rigidity
real rigidity
new Keynesian Phillips curve
JEL:E12
E31
Document Type:Working Paper
Appears in Collections:SFB 649 Discussion Papers, HU Berlin

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