We establish five facts about prices in the U.S. economy: 1) The median implied duration of consumer prices when sales are excluded at the product level is between 8 and 11 months. The median implied duration of finished goods producer prices is 8.7 months. 2) One-third of regular price changes are price decreases. 3) The frequency of price increases responds strongly to inflation while the frequency of price decreases and the size of price increases and price decreases do not. 4) The frequency of price change is highly seasonal: It is highest in the 1st quarter and lowest in the 4th quarter. 5) The hazard function of price changes for individual consumer and producer goods is downward sloping for the first few months and then flat (except for a large spike at 12 months in consumer services and all producer prices). These facts are based on CPI microdata and a new comprehensive data set of microdata on producer prices that we construct from raw production files underlying the PPI. We show that the 1st, 2nd and 3rd facts are consistent with a benchmark menu-cost model, while the 4th and 5th facts are not.

We use a micro-founded macroeconometric modeling framework to investigate the design of monetary policy when the central bank faces uncertainty about the true structure of the economy. We apply Bayesian methods to estimate the parameters of the baseline specification using postwar U.S. data and then determine the policy under commitment that maximizes household welfare. We find that the performance of the optimal policy is closely matched by a simple operational rule that focuses solely on stabilizing nominal wage inflation. Furthermore, this simple wage stabilization rule is remarkably robust to uncertainty about the model parameters and to various assumptions regarding the nature and incidence of the innovations. However, the characteristics of optimal policy are very sensitive to the specification of the wage contracting mechanism, thereby highlighting the importance of additional research regarding the structure of labor markets and wage determination.

This chapter examines the concept of inflation persistence in macroeconomic theory. It begins with a definition of persistence, emphasizing the difference between reduced-form and structural persistence. It then examines a number of empirical measures of reduced-form persistence, considering the possibility that persistence has changed over time. The chapter then examines the theoretical sources of persistence, distinguishing “intrinsic ” from “inherited” persistence, and deriving a number of analytical results on persistence. It summarizes the implications for persistence from the literatures on “stickyinformation” models, learning and so-called trend inflation models, providing some new results throughout.

Is the observed correlation between current and lagged inflation a function of backward-looking inflation expectations, or do the lags in inflation regressions merely proxy for rational forward-looking expectations, as in the new-Keynesian Phillips curve? Recent research has attempted to answer this question by using instrumental variables techniques to estimate “hybrid ” specifications for inflation that allow for effects of lagged and future inflation. We show that these tests of forward-looking behavior have very low power against alternative, but non-nested, backward-looking specifications, and demonstrate that results previously interpreted as evidence for the new-Keynesian model are also consistent with a backward-looking Phillips curve. We develop alternative, more powerful tests, which find a very limited role for forward-looking expectations.

This paper uses a structurally estimated macroeconometric model, denoted the MC model, to evaluate in ation targeting in the United States. Various interest rate rules are tried with differing weights on in ation and output, and various optimal control problems are solved using differing weights on in ation and output targets. Price-level targeting is also considered. The results show that 1) there are output costs to in ation targeting, especially for price shocks, 2) price-level targeting is dominated by in ation targeting, 3) the estimated interest rate rule of the Fed (in Table 4) is consistent with the Fed placing equal weights on in ation and unemployment in a loss function, 4) the estimated interest rate rule does a fairly good job at lowering variability, and 5) considerable economic variability is left after the Fed has done its best. Overall, the results suggest that the Fed should continue to behave as it has in the past. 1

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This paper presents a model of business cycles driven by shocks to consumer expectations regarding aggregate productivity. Agents are hit by heterogeneous productivity shocks, they observe their own productivity and a noisy public signal regarding aggregate productivity. The public signal gives rise to “noise shocks, ” which have the features of aggregate demand shocks: they increase output, employment and in‡ation in the short run and have no e¤ects in the long run. The dynamics of the economy following an aggregate productivity shock are also a¤ected by the presence of imperfect information: after a positive productivity shock output adjusts gradually to its higher long-run level, and there is a temporary negative e¤ect on in‡ation and employment. Numerical results suggest that the model can generate sizeable amounts of noise-driven volatility in the short run. JEL Codes: E32, D58, D83 Keywords: information. Consumer con…dence, aggregate demand shocks, business cycles, imperfect MIT and NBER. Email: glorenzo@mit.edu. A previous version of this paper circulated under the title:

The menu-cost interpretation of sticky prices implies that the probability of a price change should depend on the past history of prices and fundamentals only through the gap between the current price and the frictionless price. We find that this prediction is broadly consistent with the behavior of 9 Philadelphia gasoline wholesalers. We nevertheless reject the menu-cost model as a literal description of these firms' behavior, arguing instead that price stickiness arises from strategic considerations of how customers and competitors will react to price changes.

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The new-Keynesian, Taylor-rule theory of inflation determination relies on explosive dynamics. By raising interest rates in response to inflation, the Fed does not directly stabilize future inflation. Rather, the Fed threatens hyperinflation or deflation, unless inflation jumps to one particular value on each date. However, there is nothing in economics to rule out hyperinflationary or deflationary solutions. Therefore, inflation is just as indeterminate under “active ” interest rate targets as it is under standard fixed interest rate targets. Inflation determination requires ingredients beyond an interest-rate policy that follows the Taylor principle.