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Some Evolutionary Foundations for Price Level Rigidity

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  • Saint-Paul, Gilles

Abstract

This Paper shows that price rigidity evolves in an economy populated by imperfectly rational agents who experiment with alternative rules of thumb. In the model, firms must set their prices in the face of aggregate shocks. The payoff depends on the level of aggregate demand, as well as on their on price and their ‘neighbor’s’ price. The latter assumption captures local interactions. Despite the fact that the rational expectations equilibrium (REE) is characterized by a simple pricing rule that firms can easily adopt, the economy does not converge to the REE for highly correlated aggregate demand shocks and a high level of local interaction. Instead, the aggregate price level exhibits rigidity, in that it does not fully react to contemporaneous aggregate demand shocks. We show that local interactions and serial correlation of aggregate demand shocks play a key role in generating those results.

Suggested Citation

  • Saint-Paul, Gilles, 2002. "Some Evolutionary Foundations for Price Level Rigidity," CEPR Discussion Papers 3150, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:3150
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    Cited by:

    1. Alexis Anagnostopoulos & Omar Licandro & Italo Bove & Karl Schlag, 2007. "An Evolutionary Theory of Inflation Inertia," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 433-443, 04-05.
    2. repec:sbe:breart:v:28:y:2008:i:1:a:1517 is not listed on IDEAS
    3. Saint-Paul, Gilles, 2010. "A "quantum" approach to rational inattention," CEPR Discussion Papers 7739, C.E.P.R. Discussion Papers.
    4. Jaylson Jair da Silveira & Gilberto Tadeu Lima, 2007. "Regimes De Ajustamento Nominal Em Uma Macrodinâmica Evolucionária," Anais do XXXV Encontro Nacional de Economia [Proceedings of the 35th Brazilian Economics Meeting] 021, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
    5. Albert Marcet & Juan Pablo Nicolini, 2005. "Money and Prices in Models of Bounded Rationality in High Inflation Economies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 452-479, April.
    6. Gilberto Tadeu Lima & Jaylson Jair Silveira, 2015. "Monetary Neutrality Under Evolutionary Dominance Of Bounded Rationality," Economic Inquiry, Western Economic Association International, vol. 53(2), pages 1108-1131, April.
    7. repec:spa:wpaper:2013wpecon03 is not listed on IDEAS
    8. Saint-Paul, Gilles, 2017. "A “quantized” approach to rational inattention," European Economic Review, Elsevier, vol. 100(C), pages 50-71.

    More about this item

    Keywords

    adaptive learning; aggregate demand; bounded rationality; evolution; experimentation; externalities; local interaction; macroeconomic fluctuations; monetary policy; money; price rigidity; rational expectations; spillovers;

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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