The new Keynesian Phillips curve (NKPC) has become central to monetary theory and policy. A seemingly benign NKPC prediction is that trend shocks dominate price level fluctuations at all forecast horizons. Since the NKPC cycle of the U.S. GDP deflator peaks at each of the last seven NBER dated recessions, support for the NKPC is limited. The authors develop monetary business cycle models that contain different combinations of nominal (sticky-price) and real (labor market search) rigidities to understand this puzzle. Simulations indicate that a model combining labor market search and flexible prices is better able to match actual price level movements than sticky-price models do. This model represents a challenge to claims that sticky prices are a key part of the monetary transmission mechanism.
JEL classification: E3, E5
Key words: new Keynesian Phillips curve, sticky prices, labor market search, common trend, common cycle
The authors thank David Andolfatto, Paul Gomme, Francisco Gonzalez, Dave Gordon, Alain Guay, Peter Ireland, Tiff Macklem, Peter Perkins, B. Ravikumar, John Roberts, John Rogers, Juan Rubio-Ramírez, Argia Sbordone, Chris Sims, Henry Siu, Eric Smith, Gregor Smith, Antonella Trigari, Carl Walsh, (especially) Tao Zha, participants at the 2002 Bank of Canada Phillips Curve Workshop, the 2003 conference of the Society for Computational Economics at the University of Washington, and the Macro Lunch Group at the Federal Reserve Bank of Atlanta for their comments and suggestions. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors’ responsibility.
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