Florio (2018) documented, in pre–Great Recession samples with recursively identified vector autoregressions, that the price puzzle — a rise in the price level after a contractionary monetary policy shock — appears only in countries and regimes without explicit nominal anchors (United States, Japan, pre-anchor regimes) and disappears after anchor adoption (Australia, Canada, New Zealand, Sweden, Switzerland, United Kingdom, euro area), interpreting this as the effect of anchored inflation expectations. The open problem is to establish whether this regularity is robust and causally explained: whether it survives identification schemes that do not rely on the Cholesky ordering (sign restrictions, external instruments) and samples extending through the zero lower bound and unconventional policy; whether expectation anchoring is the causal mechanism rather than a coincident regime feature or the supply-side cost channel; and whether country-specific estimated price- and wage-stickiness parameters lie outside the DSGE cost-channel puzzle-producing region. No study has addressed this cross-country question; only US-side and single-country fragments exist, so the question remains open.

Background

When a central bank unexpectedly raises its policy interest rate, standard theory predicts the price level will fall. A long-standing empirical anomaly, the "price puzzle" (Sims 1992), is the opposite finding: in vector autoregressions (VARs — linear systems in which each macroeconomic variable is regressed on lagged values of all variables) identified by a recursive (Cholesky) scheme that orders the policy rate last, so that the central bank reacts contemporaneously to output and prices while a policy shock affects the real variables only with a lag, a contractionary monetary policy shock is followed by a rise rather than a fall in the price level. Two classical explanations exist. The first is forward-looking policy: if the central bank raises rates because it anticipates future inflation, the anticipated inflation appears in the data as an inflation rise after the shock; augmenting the VAR with inflation-expectation measures can remove the puzzle (Giordani 2004; Castelnuovo and Surico 2010). The second is the cost channel: if firms must finance their wage bill through short-term borrowing (a working-capital requirement), a higher policy rate raises firms' marginal costs and can raise inflation; estimated dynamic stochastic general equilibrium (DSGE) models with this channel can generate a price-puzzle region in the space of the price-stickiness and wage-stickiness parameters (Rabanal 2007).

Florio (2018) added a regime dimension. Comparing countries with clearly defined nominal anchors — explicit inflation targets or numerical price-stability commitments (Australia, Canada, New Zealand, Sweden, Switzerland, the United Kingdom, and the euro area) — with countries without such anchors (the United States and Japan), and dating regime changes following Benati (2008), she estimated three-variable Cholesky-identified VARs on country-specific pre–Great Recession windows and found the price puzzle only in unanchored countries and pre-anchor regimes. She argued that a credible anchor keeps inflation expectations anchored, removing the expectational drift that produces the puzzle. Her supporting structural exercise — a Christiano–Eichenbaum–Evans (2005) model augmented with a working-capital cost channel — showed that the cost channel can nonetheless generate a puzzle for certain combinations of the Calvo price-stickiness probability ξp\xi_p (the probability that a firm cannot reset its price in a given quarter) and wage-stickiness probability ξw\xi_w, mapped as contour regions of the impact price response over the (ξp,ξw)(\xi_p,\xi_w) grid.

Identification practice has since moved beyond recursive schemes. Sign restrictions identify policy shocks by imposing response-sign conditions rather than an ordering (Uhlig 2005). External-instrument (proxy-SVAR) methods use high-frequency financial-market surprises around policy announcements as instruments for the policy shock (Gertler and Karadi 2015); this work revealed a central-bank information effect — announcements convey the bank's assessment of the economy (Nakamura and Steinsson 2018) — and separating pure policy shocks from information shocks materially changes inference (Jarociński and Karadi 2020; Miranda-Agrippino and Ricco 2021, who find that once the signaling component of policy actions is purged, a monetary tightening is unequivocally contractionary). Separately, the measurement of expectation anchoring has been put on structural footing: Carvalho, Eusepi, Moench, and Preston (2023) build and estimate a theory in which long-run inflation expectations are endogenous and identify episodes of unanchored expectations. Finally, whether fiscal policy is "active" (not adjusted to stabilize government debt) or "passive" (Leeper 1991) changes price-level determination, and regime-dependent monetary–fiscal analysis has shown fiscal dominance can reverse standard policy prescriptions (Ascari, Florio, and Gobbi 2023). Florio (2018) further remarked that her United States commodity-price-augmented result could be consistent with a passive monetary/active fiscal mix prevailing in that period. Florio's evidence predates these developments and rests on pre–Great Recession samples and recursive identification; whether her regularity survives them is the open question.

Problem Statement

Is the disappearance of the price puzzle under nominal anchors a robust and causally explained feature of monetary transmission? Establish, as one coherent account, whether the cross-country regularity of Florio (2018) — a positive price-level response to a contractionary monetary policy shock in countries and regimes without explicit nominal anchors, and its absence after anchor adoption — holds when: (i) the monetary policy shock is identified by schemes that do not rely on the Cholesky ordering with the policy rate ordered last, such as sign restrictions or external instruments, and when samples are extended past 2008 into the zero-lower-bound episode (nominal policy rates at or near zero, leaving central banks to rely on balance-sheet and other unconventional policies); (ii) the role of anchored inflation expectations is identified causally — dating when anchoring occurred and separating its effect from the cost channel and from coincident regime changes; and (iii) country-specific estimates of the price-stickiness and wage-stickiness parameters (ξp,ξw)(\xi_p,\xi_w) from the literature place each country outside the cost-channel puzzle-producing region of the Christiano–Eichenbaum–Evans (2005)-type model — the region of the (ξp,ξw)(\xi_p,\xi_w) grid over which the model's impact price response to a contractionary shock is positive — so that the check reduces to whether each country's estimated (ξp,ξw)(\xi_p,\xi_w) yields a non-positive impact price response.

References

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