Numerous empirical studies reflect a consensus among macroeconomists that monetary policy shocks have persistent effects on aggregate measures of real activity (e.g., Leeper, Sims, and Zha (1996) and Christiano, Eichenbaum, and vans (1999)). To explain such persistence within the context of a quantitative model of the economy, many believe that price-staggering along the lines of Taylor (1980) and Blanchard (1983) is essential. Models that graft this kind of friction into a general equilibrium framework, however, have had difficulty capturing the persistence evident in the data.

In a seminal contribution, Chari, Kehoe, and McGratten (2000) (henceforth, CKM) argue that equilibrium models with small nominal frictions alone possess weak internal propagation mechanisms. Specifically, the duration of output persistence following a monetary shock does not exceed the imposed length of price fixity in the model. An unappealing consequence of this finding is that significant persistence can only be obtained if one is willing to assume a high degree of exogenous rigidity. They go on to show that the inability to return longer episodes of endogenous persistence is a result of the procyclical nature of real marginal cost. With price staggering as the sole friction, changes in aggregate demand translate into considerable variation in marginal cost, particularly real wages. As a result, firms respond by making large price adjustments when they have an opportunity to do so, inducing smaller, less persistent movements in output.