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Some Evolutionary Foundations for Price Level Rigidity

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  • Saint-Paul, Gilles

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 the face of aggregate shocks. The payoff depends on the level of aggregate demand, as well as on their on 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 highly correlated aggregate demand shocks and a high level of local interaction. Instead, the aggregate price level exhibits rigidity, in that it does not fully react to contemporaneous aggregate demand shocks. We show that local interactions and serial correlation of aggregate demand shocks play a key role in generating those results.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3150.

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Date of creation: Jan 2002
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Handle: RePEc:cpr:ceprdp:3150

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Related research

Keywords: adaptive learning; aggregate demand; bounded rationality; evolution; experimentation; externalities; local interaction; macroeconomic fluctuations; monetary policy; money; price rigidity; rational expectations; spillovers;

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Cited by:
  1. Albert Marcet & Juan Pablo Nicolini, 2005. "Money and prices in models of bounded rationality in high inflation economies," Economics Working Papers 875, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Saint-Paul, Gilles, 2010. "A "quantum" approach to rational inattention," CEPR Discussion Papers 7739, C.E.P.R. Discussion Papers.
  3. Alexis Anagnostopoulos & Italo Bove & Karl Schlag & Omar Licandro, 2006. "An Evolutionary Theory of Inflation Inertia," Working Papers 2006-25, FEDEA.
  4. 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).
  5. repec:spa:wpaper:2013wpecon03 is not listed on IDEAS

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