persistent with the staggered wage setting, he shows it is still not persistent
enough to generate the observed persistence in output. Therefore, in line
with CKM, Ascari (2000) finds that staggered wage setting cannot generate
enough output persistence.
Figure 1 illustrates how the magnitude of 7 can affect the result by show-
ing the impulse responses in two different cases. We use the value of 7
originally used by CKM and Ascari (2000), which are 7 = 1.22 and 7 = 0.20
respectively. We assume as simple Taylor economy with T = 2 (wages last
6 months). All other decisions are made quarterly. We display impulse-
response of output after a one percent monetary shock. As we can see from
Figure 1, in response to the one percent monetary shock, output displays
similar patterns in the case of 7 = 1.22 and 7 = 0.20. For both cases, output
increases when the shock hits and quickly returns to its steady state level.
For the case of 7 = 1.22, output returns to steady state level when unions
have had the opportunity to reset the wages. On the other hand, output is
certainly more persistent with 7 = 0.20, but not significantly. Finally, for
the sake of comparison, we also include the impulse response of output in the
case with 7 = 0.05 originally used by Taylor (1980), which yields a level of
persistence more in line with the evidence, but not the microfoundations.
4 Persistence in a GTE
The existing literature has tended to focus on the value 7 in generating per-
sistence. We want to explore another dimension: for a given 7, we allow for
different contract lengths in the GTE framework we have developed. Having
more than one type of contract length thus is necessary if the model is to
generate output persistence beyond the initial contract period. In what fol-
lows, we show that including longer term contracts can significantly increase
persistence. Of course, this is in a sense obvious: longer contracts lead to
more persistence, and we can achieve any level of persistence if contracts
are long enough (so long as 7 > 0). However, we want to show that even
small proportion of long-term contracts can lead to a significant increase.
Throughout this section, we will take the value of 7 = 0.2 and explore how
persistence changes when we allow for a range of contract lengths. We do
this in three stages: first we simply illustrate our case with a simple two
sector example. Second, we use Taylor’s 1993 calibrated model of the US
economy allowing for contract lengths from 1-8 quarters. Lastly, we consider
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