Another look at sticky prices and output persistence

Price rigidity is the key mechanism for propagating business cycles in traditional Keynesian theory. Yet the new Keynesian literature has failed to show that sticky prices by themselves can effectively propagate business cycles. We show that price rigidity in fact can (by itself) give rise to a strong propagation mechanism in standard models, provided that investment is also subject to a cash-in-advance constraint. Reasonable price stickiness can generate highly persistent, hump-shaped movements in output under either monetary or non-monetary shocks. Hence, whether or not price rigidity is responsible for output persistence is not a theoretical question, but an empirical one.