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Price setting frequency and the Phillips curve

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  • Gasteiger, Emanuel
  • Grimaud, Alex

Abstract

We develop a New Keynesian (NK) model with endogenous price setting frequency. Whether a firm updates its price is a discrete choice: when expected benefits outweigh expected costs, prices are reset optimally. The model gives rise to a non-linear Phillips curve as prices are more flexible during demand-driven expansions and less so during demand-driven recessions. Monetary policy can have substantial real effects despite the model having a state-dependent pricing component. Our quantitative analysis shows that contrary to the standard NK model, the assumed price setting behavior: (i) is consistent with micro data on price setting frequency; (ii) generates a direct effect of the time-varying price setting frequency on inflation; (iii) creates time-variation in the Phillips curve slope that explains shifts in the Phillips curve associated with different historical episodes; (iv) explains inflation dynamics without relying on implausible high cost-push shocks and nominal rigidities inconsistent with micro data; (v) reconciles the NK model with observed inflation moments.

Suggested Citation

  • Gasteiger, Emanuel & Grimaud, Alex, 2023. "Price setting frequency and the Phillips curve," European Economic Review, Elsevier, vol. 158(C).
  • Handle: RePEc:eee:eecrev:v:158:y:2023:i:c:s0014292123001642
    DOI: 10.1016/j.euroecorev.2023.104535
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    Cited by:

    1. Gasteiger, Emanuel & Grimaud, Alex, 2023. "Price setting frequency and the Phillips curve," European Economic Review, Elsevier, vol. 158(C).
    2. Ales Marsal & Katrin Rabitsch & Lorant Kaszab, 2023. "From Linear to Nonlinear: Rethinking Inflation Dynamics in the Calvo Pricing Mechanism," Department of Economics Working Papers wuwp350, Vienna University of Economics and Business, Department of Economics.
    3. Chen, Haixia & Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2023. "UK Monetary Policy in An Estimated DSGE Model with State-Dependent Price and Wage Contracts," Cardiff Economics Working Papers E2023/22, Cardiff University, Cardiff Business School, Economics Section.
    4. Donald Coletti, 2023. "A Blueprint for the Fourth Generation of Bank of Canada Projection and Policy Analysis Models," Discussion Papers 2023-23, Bank of Canada.

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    More about this item

    Keywords

    Price setting; Inflation dynamics; Monetary policy; Phillips curve;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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