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Menu Costs, Uncertainty Cycles, and the Propagation of Nominal Shocks

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  • Isaac Baley
  • Andrés Blanco

Abstract

Nominal shocks have long-lasting effects on real economic activity, beyond those implied by standard models that target the average frequency of price adjustment in micro data. This paper develops a price-setting model that explains this gap through the interplay of menu costs and uncertainty about idiosyncratic productivity. Uncertainty arises from firms' inability to distinguish between permanent and transitory productivity changes. Upon the arrival of a productivity shock, a firm's uncertainty spikes up and then fades with learning until the next shock arrives. These uncertainty cycles, when paired with menu costs, generate recurrent episodes of high adjustment frequency followed by episodes of low adjustment frequency at the firm level. A decreasing hazard rate of price adjustment results, as in the data. Taking into account this pricing behavior amplifies the persistence and reduces the pass-through of nominal shocks.

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  • Isaac Baley & Andrés Blanco, 2016. "Menu Costs, Uncertainty Cycles, and the Propagation of Nominal Shocks," Working Papers 918, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:918
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    2. Cosmin Ilut & Matthias Kehrig & Martin Schneider, 2018. "Slow to Hire, Quick to Fire: Employment Dynamics with Asymmetric Responses to News," Journal of Political Economy, University of Chicago Press, vol. 126(5), pages 2011-2071.
    3. Giovanni Caggiano & Efrem Castelnuovo & Gabriela Nodari, 2014. "Uncertainty and Monetary Policy in Good and Bad Times," "Marco Fanno" Working Papers 0188, Dipartimento di Scienze Economiche "Marco Fanno".
    4. Chen Yeh & David Argente, 2016. "A Menu Cost Model with Price Experimentation," 2016 Meeting Papers 1515, Society for Economic Dynamics.
    5. Bayat , Saeid & Ebrahimi , Sajad & Ghaderi , Omid, 2017. "The Effects of Exchange Rate on Price-Setting in Manufacturing Sector: Applying Price Micro Data of Iran," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 12(1), pages 1-21, January.
    6. Herwartz, Helmut & Rohloff, Hannes, 2018. "Less bang for the buck? Assessing the role of inflation uncertainty for U.S. monetary policy transmission in a data rich environment," Center for European, Governance and Economic Development Research Discussion Papers 358, University of Goettingen, Department of Economics.
    7. Castelnuovo, Efrem & Pellegrino, Giovanni, 2018. "Uncertainty-dependent effects of monetary policy shocks: A new-Keynesian interpretation," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 277-296.
    8. Laura Veldkamp & Anna Orlik, 2016. "Understanding Uncertainty Shocks and the Role of the Black Swan," Working Papers 16-04, New York University, Leonard N. Stern School of Business, Department of Economics.
    9. Matthew Klepacz, 2018. "Price Setting and Volatility: Evidence from Oil Price Volatility Shocks," 2018 Meeting Papers 145, Society for Economic Dynamics.
    10. David Berger & Joseph Vavra, 2017. "Shocks vs. Responsiveness: What Drives Time-Varying Dispersion?," NBER Working Papers 23143, National Bureau of Economic Research, Inc.
    11. de Mendonça, Helder Ferreira & Tiberto, Bruno Pires, 2017. "Effect of credibility and exchange rate pass-through on inflation: An assessment for developing countries," International Review of Economics & Finance, Elsevier, vol. 50(C), pages 196-244.

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    More about this item

    Keywords

    menu costs; uncertainty; information frictions; monetary policy; hazard rates;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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