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Precautionary price stickiness

Listed author(s):
  • Costain, James
  • Nakov, Anton

This paper proposes a model in which retail prices are sticky even though firms can always change their prices at zero cost. Instead of imposing a “menu cost”, we assume that more precise decisions are more costly. In equilibrium, firms optimally make some errors in price-setting, thus economizing on managerial time. Both the time cost of choice, and the resulting risk of errors, give firms an incentive to leave their prices unchanged until they perceive a sufficiently costly deviation from the optimal price. We show that this error-prone “control cost” framework helps explain many puzzling observations from microdata. However, on the macroeconomic side, pricing errors do little to explain the real effects of monetary shocks.

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File URL: http://www.sciencedirect.com/science/article/pii/S0165188915001219
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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 58 (2015)
Issue (Month): C ()
Pages: 218-234

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Handle: RePEc:eee:dyncon:v:58:y:2015:i:c:p:218-234
DOI: 10.1016/j.jedc.2015.06.012
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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