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Are State- and Time-Dependent Models Really Different?

Author

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  • Fernando Alvarez
  • Francesco Lippi
  • Juan Passadore
Abstract
Yes, state- and time-dependent models are really different, but only for large monetary shocks. In particular, we show that in a broad class of models where shocks have continuous paths, the propagation of a monetary impulse is independent of the nature of the sticky price friction when shocks are small. The propagation of large shocks instead depends on the nature of the friction: the impulse response of inflation to monetary shocks is independent of the shock size in time-dependent models, while it is nonlinear in state-dependent models. We use data on exchange rate devaluations and inflation for a panel of countries from 1974 to 2014 to test for the presence of state-dependent decision rules. We present some evidence of a nonlinear effect of exchange rate changes on prices in a sample of flexible exchange rate countries with low inflation. We discuss the dimensions in which this finding is robust and the ones in which it is not.

Suggested Citation

  • Fernando Alvarez & Francesco Lippi & Juan Passadore, 2017. "Are State- and Time-Dependent Models Really Different?," NBER Macroeconomics Annual, University of Chicago Press, vol. 31(1), pages 379-457.
    • Handle: RePEc:ucp:macann:doi:10.1086/690243
    DOI: 10.1086/690243
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    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General

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