Along the New Keynesian Phillips Curve with Nominal and Real Rigidities

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Abstract
The new Keynesian Phillips curve (NKPC) has become central to monetary theory and policy. A seemingly benign NKPC prediction is that trend shocks dominate price level fluctuations at all forecast horizons. Since the NKPC cycle of the U.S. GDP deflator peaks at each of the last seven NBER dated recessions, support for the NKPC is limited. We develop monetary business cycle models that contain different combinations of nominal (sticky price) and real (labor market search) rigidities to understand this puzzle. Simulations indicate a model that combines labor market search and flexible prices is better able to match actual price level movements, than do sticky price models. This represents a challenge to claims sticky prices are a key part of the monetary transmission mechanism.