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Real and Nominal Frictions within the Firm: How Lumpy Investment Matters for Price Adjustment

Listed author(s):
  • Michael K. Johnston

Real rigidities are an important feature of modern sticky price models and are policyrelevant because of their welfare consequences, but cannot be structurally identified from time series. I evaluate the plausibility of capital specificity as a source of real rigidities using a two-dimensional generalized (s,S) model calibrated to micro evidence. Capital lumpiness reduces price stickiness as endogenous fluctuations in the marginal cost of output increase willingness to pay menu costs (an extensive effect), but increases price stickiness through complementarities (an intensive effect). The extensive effect warrants higher menu costs to match evidence on price changes, and the effects of complementarities prevail.

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File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/02/wp09-36.pdf
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Paper provided by Bank of Canada in its series Staff Working Papers with number 09-36.

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Length: 42 pages
Date of creation: 2009
Handle: RePEc:bca:bocawp:09-36
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