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

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  • Isaac Baley
  • Julio A. 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.

Suggested Citation

  • Isaac Baley & Julio A. 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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    Cited by:

    1. Cosmin Ilut & Matthias Kehrig & Martin Schneider, 2014. "Slow to Hire, Quick to Fire: Employment Dynamics with Asymmetric Responses to News," Department of Economics Working Papers 150113, The University of Texas at Austin, Department of Economics, revised Dec 2014.
    2. Chen Yeh & David Argente, 2016. "A Menu Cost Model with Price Experimentation," 2016 Meeting Papers 1515, Society for Economic Dynamics.
    3. Efrem Castelnuovo & Giovanni Pellegrino, 2017. "Uncertainty-dependent Effects of Monetary Policy Shocks: A New Keynesian Interpretation," CESifo Working Paper Series 6821, CESifo Group Munich.
    4. David Berger & Joseph Vavra, 2017. "Shocks vs. Responsiveness: What Drives Time-Varying Dispersion?," NBER Working Papers 23143, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    menu costs; uncertainty; information frictions; monetary policy; hazard rates;

    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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