Long-run Phillips Curve and Disinflation Dynamics: Calvo vs. Rotemberg Price Setting

Abstract

There is widespread agreement that the two most widely used pricing assumptions in the New-Keynesian literature, i.e., Calvo and Rotemberg price-setting mechanisms, deliver equivalent dynamics. We show that, instead, they entail a very different dynamics of adjustment after a disinflation, once non linear simulations are employed. In the Calvo model disinflation implies output gains, while in the Rotemberg model a disinflation experiment implies output losses. We show that this is due to the different wedges created by the nominal rigidities in the two models: between output and hours in the Calvo model, while between output and consumption in the Rotemberg model. Moreover, unlike the Calvo model, in the Rotemberg model real wage rigidities cause a significant output slump along the adjustment path, thus restoring a dynamics in line both with the conventional wisdom and the empirical evidence.

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