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Price adjustments in a general model of state-dependent pricing

  • James Costain

    ()

    (Banco de España)

  • Antón Nákov

    ()

    (Banco de España)

In this paper, we show that a simple model of smoothly state-dependent pricing generates a distribution of price adjustments similar to that observed in microeconomic data, both for low and high inflation. Our setup is based on one fundamental assumption: price adjustment is more likely when it is more valuable. The constant probability model (Calvo 1983) and the fixed and stochastic menu cost models (Golosov and Lucas 2007; Dotsey, King and Wolman 1999) are nested as special cases of our framework. All parameterizations of our model can be ranked according to a measure of state dependence. The fixed menu cost model has the highest possible degree of state dependence; the parameterization which best fits US microdata has low state dependence. The fixed menu cost model is inconsistent with the evidence both because it never generates small price adjustments, and because it implies a large fall in the standard deviation of price adjustments as trend inflation increases. Even though the state dependence of our preferred parameterization is almost as low as that of the Calvo model, it is well-behaved when we change the steady state inflation rate, matching the data at least as well as Golosov and Lucas' model.

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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/08/Fic/dt0824e.pdf
File Function: First version, November 2008
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Paper provided by Banco de España & Working Papers Homepage in its series Working Papers with number 0824.

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Length: 43 pages
Date of creation: Nov 2008
Date of revision:
Handle: RePEc:bde:wpaper:0824
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Web page: http://www.bde.es/bde/en/secciones/informes/Publicaciones_se/docs/
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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. Mikhail Golosov & Robert E. Lucas Jr., 2007. "Menu Costs and Phillips Curves," Journal of Political Economy, University of Chicago Press, vol. 115, pages 171-199.
  3. George A. Akerlof & Janet L. Yellen, 1985. "A Near-Rational Model of the Business Cycle, with Wage and Price Inertia," The Quarterly Journal of Economics, Oxford University Press, vol. 100(Supplemen), pages 823-838.
  4. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
  5. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  6. Eduardo Engel & Ricardo Caballero, 2007. "Price stickiness in Ss models: new interpretations for old results," 2007 Meeting Papers 903, Society for Economic Dynamics.
  7. Caballero, R.J., 1994. "Explaining Investment Dynamics in U.S. Manufacturing: Generalized (S,s) Approach," Working papers 94-32, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Luis J. Álvarez, 2007. "What do micro price data tell us on the validity of the New Keynesian Phillips Curve?," Working Papers 0728, Banco de España;Working Papers Homepage.
  9. N. Gregory Mankiw, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly," The Quarterly Journal of Economics, Oxford University Press, vol. 100(2), pages 529-538.
  10. Sheedy, Kevin D., 2010. "Intrinsic inflation persistence," Journal of Monetary Economics, Elsevier, vol. 57(8), pages 1049-1061, November.
  11. Mark Gertler & John V. Leahy, 2006. "A Phillips curve with an Ss foundation," Working Papers 06-8, Federal Reserve Bank of Philadelphia.
  12. Carlos Carvalho, 2005. "Heterogeneity in Price Setting and the Real Effects of Monetary Shocks," Macroeconomics 0509017, EconWPA, revised 12 Sep 2005.
  13. James Costain & Anton Nakov, 2011. "Distributional dynamics under smoothly state-dependent pricing," Finance and Economics Discussion Series 2011-50, Board of Governors of the Federal Reserve System (U.S.).
  14. Etienne Gagnon, 2007. "Price setting during low and high inflation: evidence from Mexico," International Finance Discussion Papers 896, Board of Governors of the Federal Reserve System (U.S.).
  15. Virgiliu Midrigan, 2005. "Menu Costs, Multi-Product Firms and Aggregate Fluctuations," Macroeconomics 0511004, EconWPA.
  16. Andrew Caplin & John Leahy, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 683-708.
  17. Burstein, Ariel T., 2006. "Inflation and output dynamics with state-dependent pricing decisions," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1235-1257, October.
  18. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing and the General Equilibrium Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 655-690.
  19. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, Oxford University Press, vol. 123(4), pages 1415-1464.
  20. Carvalho Carlos, 2006. "Heterogeneity in Price Stickiness and the Real Effects of Monetary Shocks," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(3), pages 1-58, December.
  21. Caballero, Ricardo J. & Engel, Eduardo M. R. A., 1993. "Microeconomic rigidities and aggregate price dynamics," European Economic Review, Elsevier, vol. 37(4), pages 697-711, May.
  22. Peter J. Klenow & Oleksiy Kryvtsov, 2008. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," The Quarterly Journal of Economics, Oxford University Press, vol. 123(3), pages 863-904.
  23. Anil K Kashyap, 1995. "Sticky Prices: New Evidence from Retail Catalogs," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 245-274.
  24. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-13, May.
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