The Term Structure of Interest Rates and The Real Activity in a Sticky Price Model

Abstract

This paper sets up a sticky price model in which money is used to reduce the transaction costs. It shows that the contemporaneous correlations between interest rates and output of the sticky price model match well the data. It also shows that a flexible price model fails to generate interest rates as inverted leading predictors of real economic activity, while a sticky price model partly has a limited success. This paper also shows that the term spread of a sticky price model partly matches the data when there is a modest nominal rigidity.