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Sticky Prices versus Monetary Frictions: An Estimation of Policy Trade-offs
S. Borağan Aruoba, Frank Schorfheide
American Economic Journal: Macroeconomics. Jan 2011, Vol. 3, No. 1: Pages 60-90

Sticky Prices versus Monetary Frictions: An Estimation of Policy Trade-offs

S. Borağan Aruoba, 1

1Department of Economics, University of Maryland, College Park, MD 20742.

Frank Schorfheide2

2Department of Economics, University of Pennsylvania, Philadelphia, PA 19104, and NBER.

Abstract

We develop a two-sector monetary model with a centralized and decentralized market. Activities in the centralized market resemble those in a standard New Keynesian economy with price rigidities. In the decentralized market agents engage in bilateral exchanges for which money is essential. This paper is the first to formally estimate such a model, evaluate its fit based on postwar US data, and assess its money demand properties. Steady-state welfare calculations reveal that the distortions created by the monetary friction may be of similar magnitude as the distortions created by the New Keynesian friction. (JEL C54, E12, E31, E41, E52)