Partial Adjustment and Staggered Price Setting

This paper compares Taylor-style staggered price setting to partial adjustment of prices (or Calvo staggering) in a small optimizing IS/LM model. In contrast to the overwhelming perception in the literature, the models are not similar for most parameterizations. In particular, the dynamic response of the economy to shocks is quite different in the two models, and the welfare cost of price rigidity is eight or more times larger in the Calvo model than in the Taylor model (for typical calibrations). Suggestions for calibrations under which the models are more similar are also presented.