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Monetary policy implications of state-dependent prices and wages

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  • Costain, James
  • Nakov, Anton
  • Petit, Borja

Abstract

This paper studies the dynamic general equilibrium effects of monetary shocks in a "control cost" model of state-dependent retail price adjustment and state-dependent wage adjustment. Suppliers of retail goods and of labor are both monopolistic competitors that face idiosyncratic productivity shocks and nominal rigidities. Stickiness arises because precise choice is costly: decision-makers tolerate errors both in the timing of adjustments, and in the new level at which the price or wage is set, because making these choices with perfect precision would be excessively costly. The model is calibrated to microdata on the size and frequency of price and wage changes. We find that the impact multiplier of a money growth shock on consumption and labor in our calibrated state-dependent model is similar to that in a Calvo model with the same adjustment frequencies, though the response is less persistent than it would be under the Calvo mechanism. Wage rigidity accounts for most of the nonneutrality that occurs in a model where both prices and wages are sticky; hence, a model with both rigidities produces substantially larger real effects of monetary shocks than does a model with sticky prices only. We find that the state-dependence of nominal rigidity strongly decreases the slope of the Phillips curve as trend inflation declines. This result is not driven by downward wage rigidity; adjustment costs are symmetric in our model. Here, instead, price- and wage-setters prefer to adjust less frequently when trend inflation is low, making short-run inflation less reactive to shocks.

Suggested Citation

  • Costain, James & Nakov, Anton & Petit, Borja, 2018. "Monetary policy implications of state-dependent prices and wages," CEPR Discussion Papers 13398, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:13398
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    Cited by:

    1. Fabian Eser & Peter Karadi & Philip R. Lane & Laura Moretti & Chiara Osbat, 2020. "The Phillips Curve at the ECB," Manchester School, University of Manchester, vol. 88(S1), pages 50-85, September.
    2. Shuhei Takahashi, 2018. "Does State-Dependent Wage Setting Generate Multiple Equilibria?," KIER Working Papers 991, Kyoto University, Institute of Economic Research.
    3. James Costain, 2017. "Costly decisions and sequential bargaining," Working Papers 1729, Banco de España;Working Papers Homepage.
    4. Le, Vo Phuong Mai & Meenagh, David & Minford, Patrick, 2020. "State-dependent pricing turns money into a two-edged sword," Cardiff Economics Working Papers E2019/15, Cardiff University, Cardiff Business School, Economics Section.
    5. Guido Ascari & Timo Haber, 2019. "Sticky prices and the transmission mechanism of monetary policy: A minimal test of New Keynesian models," Economics Series Working Papers 869, University of Oxford, Department of Economics.

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    More about this item

    Keywords

    control costs; logit equilibrium; near rationality; state-dependent adjustment; sticky prices; sticky wages;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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