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Abstract:
One of the criticisms routinely advanced against models
of the business cycle with staggered contracts is their inability
to generate inflation persistence. This paper finds that staggered
Taylor contracts are, in fact, capable of reproducing the
inflation persistence implied by U.S. data. Following Fuhrer and
Moore, I capture the moments that the contract specification needs
to replicate by using the correlograms from a small vector
autoregression (VAR) that includes inflation among the endogenous
variables. A simple structural model substitutes the inflation
equation from the VAR with the contract specification. I estimate
the contract parameters in the structural model by maximum
likelihood. The correlogram for the endogenous variables from the
estimated structural model, including that for inflation, are very
close to the correlograms from the VAR (and are contained within
their 90% confidence intervals). By the same metric, where Taylor
contracts do not fare well is in reproducing the
cross-correlations between inflation and output.
Full paper (307 KB PDF)
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