IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Precautionary price stickiness

  • Costain, James
  • Nakov, Anton

This paper proposes two models in which price stickiness arises endogenously even though firms are free to change their prices at zero physical cost. Firms are subject to idiosyncratic and aggregate shocks, and they also face a risk of making errors when they set their prices. In our first specification, firms are assumed to play a dynamic logit equilibrium, which implies that big mistakes are less likely than small ones. The second specification derives logit behavior from an assumption that precision is costly. The empirical implications of the two versions of our model are very similar. Since firms making sufficiently large errors choose to adjust, both versions generate a strong "selection effect" in response to a nominal shock that eliminates most of the monetary nonneutrality found in the Calvo model. Thus the model implies that money shocks have little impact on the real economy, as in Golosov and Lucas (2007), but fits microdata better than their specification. JEL Classification: E31, D81, C72

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

Paper provided by European Central Bank in its series Working Paper Series with number 1375.

in new window

Date of creation: Aug 2011
Date of revision:
Handle: RePEc:ecb:ecbwps:20111375
Contact details of provider: Postal:
60640 Frankfurt am Main, Germany

Phone: +49 69 1344 0
Fax: +49 69 1344 6000
Web page:

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Peter J. Klenow & Oleksiy Kryvtsov, 2008. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," The Quarterly Journal of Economics, Oxford University Press, vol. 123(3), pages 863-904.
  2. Michael Reiter, 2006. "Solving heterogeneous-agent models by projection and perturbation," Economics Working Papers 972, Department of Economics and Business, Universitat Pompeu Fabra.
  3. Kiley, Michael T, 2002. "Partial Adjustment and Staggered Price Setting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 283-98, May.
  4. George A. Akerlof & Janet L. Yellen, 1985. "A Near-Rational Model of the Business Cycle, with Wage and Price Inertia," The Quarterly Journal of Economics, Oxford University Press, vol. 100(Supplemen), pages 823-838.
  5. Alvarez, Fernando & Lippi, Francesco & Paciello, Luigi, 2010. "Optimal price setting with observation and menu costs," CEPR Discussion Papers 7861, C.E.P.R. Discussion Papers.
  6. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-13, May.
  7. Mackowiak, Bartosz Adam & Wiederholt, Mirko, 2010. "Business Cycle Dynamics under Rational Inattention," CEPR Discussion Papers 7691, C.E.P.R. Discussion Papers.
  8. Costain, James & Nakov, Anton, 2011. "Distributional dynamics under smoothly state-dependent pricing," Journal of Monetary Economics, Elsevier, vol. 58(6), pages 646-665.
  9. Robert J. Barro, 1972. "A Theory of Monopolistic Price Adjustment," Review of Economic Studies, Oxford University Press, vol. 39(1), pages 17-26.
  10. Filip Matejka, 2010. "Rationally Inattentive Seller: Sales and Discrete Pricing," CERGE-EI Working Papers wp408, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
  11. Woodford, Michael, 2009. "Information-constrained state-dependent pricing," Journal of Monetary Economics, Elsevier, vol. 56(S), pages S100-S124.
  12. Kevin D. Sheedy, 2007. "Inflation persistence when price stickiness differs between industries," LSE Research Online Documents on Economics 3738, London School of Economics and Political Science, LSE Library.
  13. Fernando Alvarez & Francesco Lippi, 2014. "Price Setting With Menu Cost for Multiproduct Firms," Econometrica, Econometric Society, vol. 82(1), pages 89-135, 01.
  14. N. Gregory Mankiw, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly," The Quarterly Journal of Economics, Oxford University Press, vol. 100(2), pages 529-538.
  15. Andrew C. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," NBER Working Papers 2311, National Bureau of Economic Research, Inc.
  16. Simon P. Anderson & Jacob K. Goeree & Charles A. Holt, 2002. "The Logit Equilibrium: A Perspective on Intuitive Behavioral Anomalies," Southern Economic Journal, Southern Economic Association, vol. 69(1), pages 21-47, July.
  17. Filip Matêjka & Alisdair McKay, 2015. "Rational Inattention to Discrete Choices: A New Foundation for the Multinomial Logit Model," American Economic Review, American Economic Association, vol. 105(1), pages 272-98, January.
  18. Mark J. Zbaracki & Mark Ritson & Daniel Levy & Shantanu Dutta & Mark Bergen, 2004. "Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets," The Review of Economics and Statistics, MIT Press, vol. 86(2), pages 514-533, May.
  19. Philip A. Haile & Ali Hortacsu & Grigory Kosenok, 2003. "On the Empirical Content of Quantal Response Equilibrium," Cowles Foundation Discussion Papers 1432, Cowles Foundation for Research in Economics, Yale University.
  20. Michael Dotsey & Robert G. King, 2005. "Implications of State Dependent-Pricing for Dynamic Macroeconomic Models," Boston University - Department of Economics - Macroeconomics Working Papers Series WP2005-002, Boston University - Department of Economics.
  21. Luis J. Álvarez, 2007. "What do micro price data tell us on the validity of the New Keynesian Phillips Curve?," Working Papers 0728, Banco de España;Working Papers Homepage.
  22. Costain, James & Nakov, Anton, 2015. "Logit Price Dynamics," CEPR Discussion Papers 10731, C.E.P.R. Discussion Papers.
  23. Mark Gertler & John Leahy, 2006. "A Phillips Curve with an Ss Foundation," NBER Working Papers 11971, National Bureau of Economic Research, Inc.
  24. Etienne Gagnon, 2009. "Price Setting during Low and High Inflation: Evidence from Mexico," The Quarterly Journal of Economics, Oxford University Press, vol. 124(3), pages 1221-1263.
  25. Leif Danziger, 1998. "A Dynamic Economy with Costly Price Adjustment," Cahiers de recherche CREFE / CREFE Working Papers 83, CREFE, Université du Québec à Montréal.
  26. Caballero, Ricardo J. & Engel, Eduardo M. R. A., 1993. "Microeconomic rigidities and aggregate price dynamics," European Economic Review, Elsevier, vol. 37(4), pages 697-711, May.
  27. Eichenbaum, Martin & Jaimovich, Nir & Rebelo, Sérgio, 2008. "Reference Prices and Nominal Rigidities," CEPR Discussion Papers 6709, C.E.P.R. Discussion Papers.
  28. Peter J. Klenow & Benjamin A. Malin, 2010. "Microeconomic Evidence on Price-Setting," NBER Working Papers 15826, National Bureau of Economic Research, Inc.
  29. Kevin D. Sheedy, 2007. "Intrinsic Inflation Persistence," CEP Discussion Papers dp0837, Centre for Economic Performance, LSE.
  30. Robert G. King & Alexander Wolman & Michael Dotsey, 2009. "Inflation and Real Activity with Firm Level Productivity Shocks," 2009 Meeting Papers 367, Society for Economic Dynamics.
  31. Basu, Susanto, 2005. "Comment on: "Implications of state-dependent pricing for dynamic macroeconomic modeling"," Journal of Monetary Economics, Elsevier, vol. 52(1), pages 243-247, January.
  32. Richard Blundell & Stephen Bond, 2000. "GMM Estimation with persistent panel data: an application to production functions," Econometric Reviews, Taylor & Francis Journals, vol. 19(3), pages 321-340.
  33. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
  34. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, Oxford University Press, vol. 123(4), pages 1415-1464.
  35. Saul Lach & Daniel Tsiddon, 2007. "Small price changes and menu costs," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(7), pages 649-656.
  36. Tutino, Antonella, 2008. "The rigidity of choice: lifetime savings under information-processing constraints," MPRA Paper 16744, University Library of Munich, Germany, revised 24 Jul 2009.
  37. Michael Dotsey & Robert G. King & Alexander L. Wolman, 1999. "State-Dependent Pricing and the General Equilibrium Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 655-690.
  38. Stahl, D O, 1990. "Entropy Control Costs and Entropic Equilibria," International Journal of Game Theory, Springer;Game Theory Society, vol. 19(2), pages 129-38.
  39. Ricardo J. Caballero, 1991. "A Fallacy of Composition," NBER Working Papers 3735, National Bureau of Economic Research, Inc.
  40. Mikhail Golosov & Robert E. Lucas Jr., 2007. "Menu Costs and Phillips Curves," Journal of Political Economy, University of Chicago Press, vol. 115, pages 171-199.
  41. Anil K Kashyap, 1995. "Sticky Prices: New Evidence from Retail Catalogs," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 245-274.
  42. Jeffrey R. Campbell & Benjamin Eden, 2014. "Rigid Prices: Evidence From U.S. Scanner Data," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 55, pages 423-442, 05.
  43. Andrew Caplin & John Leahy, 1991. "State-Dependent Pricing and the Dynamics of Money and Output," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 683-708.
  44. Virgiliu Midrigan, 2011. "Menu Costs, Multiproduct Firms, and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 79(4), pages 1139-1180, 07.
  45. Martin Eichenbaum & Nir Jaimovich & Sergio Rebelo, 2011. "Reference Prices, Costs, and Nominal Rigidities," American Economic Review, American Economic Association, vol. 101(1), pages 234-62, February.
  46. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  47. Marsili, Matteo, 1999. "On the multinomial logit model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 269(1), pages 9-15.
  48. James Costain & Antón Nákov, 2008. "Price adjustments in a general model of state-dependent pricing," Working Papers 0824, Banco de España;Working Papers Homepage.
  49. Mattsson, Lars-Goran & Weibull, Jorgen W., 2002. "Probabilistic choice and procedurally bounded rationality," Games and Economic Behavior, Elsevier, vol. 41(1), pages 61-78, October.
  50. Etienne Gagnon, 2006. "Price Setting during Low and High Inflation: Evidence from Mexico," 2006 Meeting Papers 300, Society for Economic Dynamics.
  51. Richard Mckelvey & Thomas Palfrey, 1998. "Quantal Response Equilibria for Extensive Form Games," Experimental Economics, Springer, vol. 1(1), pages 9-41, June.
  52. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  53. Eytan Sheshinski & Yoram Weiss, 1977. "Inflation and Costs of Price Adjustment," Review of Economic Studies, Oxford University Press, vol. 44(2), pages 287-303.
  54. Carvalho Carlos, 2006. "Heterogeneity in Price Stickiness and the Real Effects of Monetary Shocks," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(3), pages 1-58, December.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:ecb:ecbwps:20111375. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Official Publications)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.