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Price stickiness in Ss models: new interpretations for old results

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  • Eduardo Engel

    (Yale)

  • Ricardo Caballero

    (MIT)

Abstract

What is the relation between infrequent price adjustment and the dynamic response of the aggregate price level to monetary shocks? The answer to this question ranges from a one-to-one link (Calvo, 1983) to no connection whatsoever (Caplin and Spulber, 1987). The purpose of this paper is to provide a unified framework to understand the mechanisms behind this wide range of results. In doing so, we provide new interpretations of key results in this area. In particular, when price stickiness is measured in terms of the impulse response function, the monetary neutrality result of Caplin and Spulber is not a consequence of aggregation, as is often assumed, but is due instead to properties of the microeconomic impulse response function. We also show that the ”selection effect,” according to which units that adjust their prices are those that benefit the most, is an important feature of Ss-type models but is neither necessary nor sufficient to account for the higher aggregate flexibility of these models compared to Calvo models. Instead, the key concept is the contribution of the extensive margin of adjustment to the aggregate price response. The aggregate price level is more flexible than suggested by the microeconomic frequency of adjustment if and only if this term is positive.

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Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 903.

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Date of creation: 2007
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Handle: RePEc:red:sed007:903

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