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Some Evolutionary Foundations for Price Level Rigidity

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  • Gilles Saint-Paul

Abstract

This paper shows that price rigidity evolves in an economy populated by imperfectly rational agents who experiment with alternative rules of thumb. In the model, firms must set their prices in face of aggregate demand shocks. Their payoff depends on the level of aggregate demand, as well as on their own price and their "neighbor's" price. The latter assumption captures local interactions. Despite the fact that the rational expectations equilibrium (REE) is characterized by a simple pricing rule that firms can easily adopt, the economy does not converge to the REE for all parameter values. When the volatility of monetary innovations is low and interactions among firms are high, the aggregate price level exhibits rigidity, in that it does not fully react to contemporaneous aggregate demand shocks. We discuss the role of the nature of experimentation, and of path dependence driven by interactions, in explaining these results.

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 95 (2005)
Issue (Month): 3 (June)
Pages: 765-779

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Handle: RePEc:aea:aecrev:v:95:y:2005:i:3:p:765-779

Note: DOI: 10.1257/0002828054201251
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Cited by:
  1. Alexis Anagnostopoulos & Omar Licandro & Italo Bove & Karl Schlag, 2006. "An Evolutionary Theory of Inflation Inertia," Economics Working Papers ECO2006/33, European University Institute.
  2. Jaylson Jair da Silveira & Gilberto Tadeu Lima, 2007. "Regimes De Ajustamento Nominal Em Uma Macrodinâmica Evolucionária," Anais do XXXV Encontro Nacional de Economia [Proceedings of the 35th Brazilian Economics Meeting] 021, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  3. Gilberto Tadeu Lima & Jaylson Jair da Silveira, 2013. "Monetary Neutrality under Evolutionary Dominance of Bounded Rationality," Working Papers, Department of Economics 2013_03, University of São Paulo (FEA-USP).
  4. Marcet, Albert & Nicolini, Juan Pablo, 2005. "Money and prices in models of bounded rationality in high inflation economies," Working Paper Series 0469, European Central Bank.
  5. Saint-Paul, Gilles, 2010. "A "quantum" approach to rational inattention," CEPR Discussion Papers 7739, C.E.P.R. Discussion Papers.
  6. repec:spa:wpaper:2013wpecon03 is not listed on IDEAS

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