Sticky Prices vs Limited Participation: What do we Learn from the Data?
The method of maximum likelihood is used to estimate a Dynamic Stochastic General Equilibrium business cycle model that combines elements of existing sticky-price and limited-participation specifications. Sticky prices are incorporated, following Rotemberg (1982), by assuming that monopolistically competitive firms face a quadratic cost of nominal price adjustment. Limited participation is incorporated, following Cooley and Quadrini (1999), by assuming that households face a quadratic cost of portfolio adjustment.The results support the hypothesis that the degree of the portfolio adjustment is very small in the data, but significant. In addition, the data suggest that the response of the interest rate to deviations of output from the steady state in the interest rate rule should be very close to zero. This is argued by Christiano and Gust (1999) as well. Furthermore, as in Ireland (1999, 2000), the model can not reject the hypothesis of parameter stability for the policy parameters. On the other hand, the model rejects the hypothesis for the rest of the parameters.
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