Does inflation increase after a monetary policy tightening? Answers based on an estimated DSGE model

This paper estimates the importance of the cost channel of monetary policy in a New Keynesian model of the business cycle. A model with nominal and real rigidities is extended by assuming that a fraction of firms need to borrow money to pay their wage bill. Hence, a monetary policy tightening increases effective unit labor costs of production, and might imply an increase in inflation. The paper examines the conditions under which the model can generate a positive response of inflation to a monetary contraction, and estimates the model's parameters using Bayesian methods. The paper shows that the estimated demand-side effects of monetary policy dominate the estimated supply side effect, even if restrictions are imposed that make occurrence of a positive inflation response to a monetary contraction more likely.