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Firm-Specific Capital and the New Keynesian Phillips Curve

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  • Woodford, Michael

Abstract

A relation between inflation and the path of average marginal cost (often measured by unit labor cost) implied by the Calvo (1983) model of staggered pricing – sometimes referred to as the "New Keynesian" Phillips curve – has been the subject of extensive econometric estimation and testing. Standard theoretical justifications of this form of aggregate-supply relation, however, either assume (1) the existence of a competitive rental market for capital services, so that the shadow cost of capital services is equated across firms and sectors at all points in time, despite the fact that prices are set at different times, or (2) that the capital stock of each firm is constant, or at any rate exogenously given, and so independent of the firm’s pricing decision. But neither assumption is realistic. The present paper examines the extent to which existing empirical specifications and interpretations of parameter estimates are compromised by reliance on either of these assumptions. The paper derives an aggregate-supply relation for a model with monopolistic competition and Calvo pricing in which capital is firm specific and endogenous, and investment is subject to convex adjustment costs. The aggregate-supply relation is shown to again take the standard New Keynesian form, but with an elasticity of inflation with respect to real marginal cost that is a different function of underlying parameters than in the simpler cases studied earlier. Thus the relations estimated in the empirical literature remain correctly specified under the assumptions proposed here, but the interpretation of the estimated elasticity is different; in particular, the implications of the estimated Phillips-curve slope for the frequency of price adjustment is changed. Assuming a rental market for capital results in a substantial exaggeration of the infrequency of price adjustment; assuming exogenous capital instead results in a smaller underestimate.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 825.

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Date of creation: 08 Feb 2005
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Publication status: Published in International Journal of Central Banking Number 2.Volume(2005): pp. 1-46
Handle: RePEc:pra:mprapa:825

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  1. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  2. Miles S. Kimball & Michael Woodford, 1994. "The quantitative analysis of the basic neomonetarist model," Proceedings, Federal Reserve Bank of Cleveland, pages 1241-1289.
  3. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  4. Martin Eichenbaum & Jonas D.M. Fisher, 2004. "Evaluating the Calvo Model of Sticky Prices," NBER Working Papers 10617, National Bureau of Economic Research, Inc.
  5. Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc.
  6. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," NBER Working Papers 11034, National Bureau of Economic Research, Inc.
  7. Jordi Gali & Mark Gertler & J. David Lopez-Salido, 2001. "European Inflation Dynamics," NBER Working Papers 8218, National Bureau of Economic Research, Inc.
  8. Laurence Ball & David Romer, 1987. "Real Rigidities and the Non-Neutrality of Money," NBER Working Papers 2476, National Bureau of Economic Research, Inc.
  9. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
  10. Julien Matheron, 2006. "Firm-Specific Labor and Firm-Specific Capital: Implications for the Euro-Data New Phillips Curve," International Journal of Central Banking, International Journal of Central Banking, vol. 2(4), December.
  11. Tommy Sveen & Lutz Weinke, 2004. "Pitfalls in the modeling of forward-looking price setting and investment decisions," Economics Working Papers 773, Department of Economics and Business, Universitat Pompeu Fabra.
  12. Andrew Levin & Günter Coenen, 2005. "Identifying the Influences of Nominal and Real Rigidities in Aggregate Price-Setting Behavior," Computing in Economics and Finance 2005 66, Society for Computational Economics.
  13. Sbordone, Argia, 1998. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Seminar Papers 653, Stockholm University, Institute for International Economic Studies.
  14. David Altig & Lawrence Christiano & Martin Eichenbaum & Jesper Linde, 2005. "Online Appendix to "Firm-Specific Capital, Nominal Rigidities and the Business Cycle"," Technical Appendices 09-191, Review of Economic Dynamics.
  15. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
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