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Large shocks in menu cost models

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  • Karadi, Peter
  • Reiff, Adam

Abstract

How do prices react to large aggregate shocks? Our new micro-data evidence on value-added tax changes shows that prices react (i) flexibly and (ii) asymmetrically to large positive and negative shocks. We use it to quantitatively evaluate the performance of prominent pricing models. We show that standard time-dependent models are unable to reproduce either of these facts. A realistically calibrated state-dependent menu cost model, in contrast, is successful in matching the observed price responses. Its success lies in its ability to capture the exploding fraction of price changes for large shocks. The evidence facilitates comparison of different menu cost models and raises doubts on alternative pricing models with information or search frictions as sole reasons for price rigidity. JEL Classification: E31, E52

Suggested Citation

  • Karadi, Peter & Reiff, Adam, 2012. "Large shocks in menu cost models," Working Paper Series 1453, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20121453
    Note: 1871516
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    References listed on IDEAS

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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. When state-dependent pricing dominates time-dependent pricing
      by Economic Logician in Economic Logic on 2012-09-26 19:39:00

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    Cited by:

    1. Elsby, Michael W.L. & Michaels, Ryan, 2019. "Fixed adjustment costs and aggregate fluctuations," Journal of Monetary Economics, Elsevier, vol. 101(C), pages 128-147.
    2. Adam Reiff & Peter Karadi, 2011. "Large Shocks in Menu Cost Models," 2011 Meeting Papers 884, Society for Economic Dynamics.
    3. Ray, Sourav & Wang, Li & Levy, Daniel & Bergen, Mark, 2019. "Pricing Better," MPRA Paper 95654, University Library of Munich, Germany.
      • Sourav Ray & Li Wang & Daniel Levy & Mark Bergen, 2019. "Pricing Better," Working Paper series 19-16, Rimini Centre for Economic Analysis.
      • Ray, Sourav & Wang, Li & Levy, Daniel & Bergen, Mark, 2019. "Pricing Better," MPRA Paper 95596, University Library of Munich, Germany.
      • Daniel Levy & Sourav Ray & Li Wang & Mark Bergen, 2019. "Pricing Better," Working Papers 008-19 JEL Codes: M31, E3, International School of Economics at TSU, Tbilisi, Republic of Georgia.
      • Ray, Sourav & Wang, Li & Levy, Daniel & Bergen, Mark, 2019. "Pricing Better," EconStor Preprints 201843, ZBW - Leibniz Information Centre for Economics.
      • Daniel Levy & Mark Bergen, 2019. "Pricing Better," Working Papers 2019-07, Bar-Ilan University, Department of Economics.
    4. Wolters Maik H. & Tillmann Peter, 2015. "The changing dynamics of US inflation persistence: a quantile regression approach," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 19(2), pages 161-182, April.
    5. Emi Nakamura & Jón Steinsson, 2013. "Price Rigidity: Microeconomic Evidence and Macroeconomic Implications," Annual Review of Economics, Annual Reviews, vol. 5(1), pages 133-163, May.
    6. Chen Yeh & David Argente, 2016. "A Menu Cost Model with Price Experimentation," 2016 Meeting Papers 1515, Society for Economic Dynamics.
    7. Lanne Markku, 2015. "Noncausality and inflation persistence," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 19(4), pages 469-481, September.

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    More about this item

    Keywords

    Inflation asymmetry; state-dependent pricing; time-dependent pricing; value-added tax shock;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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