Nominal price rigidity, money supply endogeneity, and business cycles

Abstract This paper investigates the ability of nominal price rigidity to explain the co-movement of inflation with the cyclical component of output observed in the post-war U.S. data. A dynamic general equilibrium model is constructed with the introduction of monopolistic competition and nominal price rigidity in a standard real business cycle model, allowing for an endogenous money supply rule. It is then demonstrated that sticky price models can explain the observed associations between movements in inflation and output much better than flexible price models. This result depends little on whether money supply is assumed to be endogenous or not.