Nonlinearities of Monetary Policy across States of Price Rigidity

Abstract

This paper analyzes the nonlinear effects of monetary policy across states of price rigidity. Consumer prices in the United Kingdom exhibit distinct cyclical patterns, with more frequent price changes in recessions than in expansions, and the frequency increases with inflation. Using these patterns to inform nonlinear local projection models of states of flexible and rigid price adjustment, I find that economic activity responds more strongly and prices more slowly to monetary policy shocks in periods of rigid compared to flexible prices. This provides microfounded evidence for the state dependence of monetary policy on the price-setting behavior of firms.