Price Bargaining, the Persistence Puzzle, and Monetary Policy

In the recent New Keynesian literature a standard assumption is that the price for which an intermediate good is sold to the final good firm is equal to the marginal costs of the intermediate good firm. However, there is empirical evidence that this need not to hold. This paper introduces price bargaining into an otherwise standard New Keynesian DSGE model and shows that this model performs reasonably well in replicating the observed persistence values.

We further discuss the role of those product market imperfections for monetary policy and find a trade-off between stabilizing intermediate or final good inflation. In addition, the Ramsey optimal monetary policy can be approximated reasonably well with a Taylor-type interest rate rule with weights on both inflation rates and output.