Investigating A Countercyclical Price Level With Procyclical Inflation PDF Download

The purpose of this paper is focus directly on the phase shift. For one thing, we ask whether a sticky-price model economy can account for both countercyclical prices and procyclical inflation. We present findings in which the price level is countercyclical and the inflation rate is procyclical. We proceed to use the model economy as an identification mechanism. What set of individual shocks are sufficient to account for the phase shift? That set is empty. Next, we ask what set of shocks are necessary to account for the phase shift. This set contains technology shocks and monetary policy shocks. The results are important as a building block. We infer that price stickiness is an important model feature; without price stickiness, we are in the real business cycle economies that Cooley and Hansen studied. But, it raises further questions. For instance, is price stickiness of the Rotemberg form -- the one used here -- necessary to explain the phase shift? Our contribution is twofold. First, we use a sticky-price model economy to determine if it can account for both countercyclical prices and procyclical inflation. By examining the phase shift, we use the natural feature that the two facts are part of one fact; the inflation rate is the rate of change in the price level. The working hypothesis is that sticky prices are an important ingredient so that the equilibrium laws of motion will generate the phase shift. Further, note that Brock and Haslag suggest that some kind of stickiness is necessary.