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Financial Constraints and Nominal Price Rigidities

Author

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  • Balleer, Almut
  • Hristov, Nikolay
  • Menno, Dominik

Abstract

This paper investigates how financial market imperfections and the frequency of price adjustment interact. Based on new firm-level evidence for Germany, we document that financially constrained firms adjust prices more often than their unconstrained counterparts, both upwards and downwards. We show that these empirical patterns are consistent with a partial equilibrium menu-cost model with a working capital constraint. We then use the model to show how the presence of financial frictions changes profits and the price distribution of firms compared to a model without financial frictions. Our results suggest that tighter financial constraints are associated with higher nominal rigidities, higher prices and lower output. Moreover, in response to aggregate shocks, aggregate price rigidity moves substantially, the response of inflation is dampened, while output reacts more in the presence of financial frictions. This means that financial frictions make the aggregate supply curve flatter for all calibrations considered in our model. We show that this differs fundamentally from models in which the extensive margin of price adjustment is absent (Rotemberg, 1982) or constant (Calvo, 1983). Hence, the interaction of financial frictions and the frequency of price adjustment potentially induces important consequences for the effectiveness of monetary policy.

Suggested Citation

  • Balleer, Almut & Hristov, Nikolay & Menno, Dominik, 2017. "Financial Constraints and Nominal Price Rigidities," CEPR Discussion Papers 11790, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11790
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    References listed on IDEAS

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    Cited by:

    1. Donato Masciandaro, 2018. "Central Banking and Macroeconomic Ideas: Economics, Politics and History," BAFFI CAREFIN Working Papers 1858, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.

    More about this item

    Keywords

    Financial Frictions; Frequency of price adjustment; menu cost model;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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