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Sticky Prices, Coordination and Collusion

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  • John C. Driscoll
  • Harumi Ito

Abstract

New Keynesian models of price setting under monopolistic competition involve two kinds of inefficiency: the price level is too high because firms ignore an aggregate demand externality, and when there are costs of changing prices, price stickiness may be an equilibrium response to changes in nominal money even when all agents would be better off if all adjusted prices. This paper models the consequences of allowing firms to coordinate, enforcing the coordination by punishing deviators; this is equivalent to modeling firms as an implicit cartel playing a punishment game. We show that coordination can partially or fully eliminate the first kind of inefficiency, depending on the magnitude of the punishment, but cannot always remove the second. The response of prices to a monetary shock will depend on the magnitude of the punishment, and may be asymmetric. Implications for the welfare cost of fluctuations also differ from the standard monopolistic competition case.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7165.

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Date of creation: Jun 1999
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Publication status: published as Driscoll, John C. and Harumi Ito. "Sticky Prices, Coordination And Enforcement," Topics in Macroeconomics, 2003, v3, Article 10.
Handle: RePEc:nbr:nberwo:7165

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  1. Karl Brunner & Allan H. Meltzer, 1968. "Liquidity Traps for Money, Bank Credit, and Interest Rates," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 76, pages 1.
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  7. Caplin, Andrew & Leahy, John, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(3), pages 683-708, August.
  8. Julio J. Rotemberg & Michael Woodford, 1991. "Markups and the Business Cycle," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 1991, Volume 6, pages 63-140 National Bureau of Economic Research, Inc.
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Cited by:
  1. V. Bhaskar, 2002. "Asymmetric Price Adjustment: Micro-foundations and Macroeconomic Implications," Economics Discussion Papers, University of Essex, Department of Economics 547, University of Essex, Department of Economics.

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