Input-output structure and the general equilibrium dynamics of inflation and output

Recent empirical studies reveal that monetary shocks cause persistent fluctuations in inflation and aggregate output. In the literature, few mechanisms have been identified to generate such persistence. In this paper, we propose a new mechanism that does so. Our model features an input-output structure and staggered price contracts. Working through the input-output relations and the timing of firms’ pricing decisions, the model generates smaller fluctuations in marginal cost facing firms at later stages than at earlier stages and hence persistent responses of both the inflation rate and aggregate output following a monetary stock. The persistence is larger, the greater the number of production stages. With a sufficient number of stages, the real persistence is arbitrarily large.