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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
7165.
Length: Date of creation: Jun 1999 Date of revision: 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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Find related papers by JEL classification: D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Susan Athey & Kyle Bagwell & Chris Sanchirico, 1998.
"Collusion and Price Rigidity,"
Working papers
98-23, Massachusetts Institute of Technology (MIT), Department of Economics.
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