The Macroeconomic Controversy Over Price Rigidity — How to Resolve it and How Bayesian Estimation has Led us Astray

Abstract

Price rigidity plays a central role in macroeconomic models but remains controversial. Those espousing it look to Bayesian estimated models in support, while those assuming price flexibility largely impose it on their models. So controversy continues unresolved by testing on the data. In a Monte Carlo experiment we ask how different estimation methods could help to resolve this controversy. We find Bayesian estimation creates a large potential estimation bias compared with standard estimation techniques. Indirect estimation where the bias is found to be low appears to do best, and offers the best way forward for settling the price rigidity controversy.