IDEAS home Printed from https://ideas.repec.org/p/ecb/ecbwps/20121453.html
   My bibliography  Save this paper

Large shocks in menu cost models

Author

Listed:
  • 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
    as

    Download full text from publisher

    File URL: https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1453.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    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 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.
    3. Cabral, Luís & Fishman, Arthur, 2012. "Business as usual: A consumer search theory of sticky prices and asymmetric price adjustment," International Journal of Industrial Organization, Elsevier, pages 371-376.
    4. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
    5. 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.
    6. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    7. Costain, James & Nakov, Anton, 2011. "Distributional dynamics under smoothly state-dependent pricing," Journal of Monetary Economics, Elsevier, vol. 58(6), pages 646-665.
    8. Andrew S. Caplin & Daniel F. Spulber, 1987. "Menu Costs and the Neutrality of Money," The Quarterly Journal of Economics, Oxford University Press, vol. 102(4), pages 703-725.
    9. Jaccard Ivan, 2011. "Asset Pricing and Housing Supply in a Production Economy," The B.E. Journal of Macroeconomics, De Gruyter, pages 1-40.
    10. Bartosz Mackowiak & Mirko Wiederholt, 2009. "Optimal Sticky Prices under Rational Inattention," American Economic Review, American Economic Association, pages 769-803.
    11. Klenow, Peter J. & Malin, Benjamin A., 2010. "Microeconomic Evidence on Price-Setting," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 6, pages 231-284 Elsevier.
    12. Michael B. Devereux & Henry E. Siu, 2007. "State Dependent Pricing And Business Cycle Asymmetries," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 48(1), pages 281-310, February.
    13. Mark Gertler & John Leahy, 2008. "A Phillips Curve with an Ss Foundation," Journal of Political Economy, University of Chicago Press, vol. 116(3), pages 533-572, June.
    14. Adam Reiff & Peter Karadi, 2011. "Large Shocks in Menu Cost Models," 2011 Meeting Papers 884, Society for Economic Dynamics.
    15. Laurent Baudry & Hervé Le Bihan & Patrick Sevestre & Sylvie Tarrieu, 2007. "What do Thirteen Million Price Records have to Say about Consumer Price Rigidity?," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 69(2), pages 139-183, April.
    16. Ellingsen, Tore & Friberg, Richard & Hassler, John, 2006. "Menu Costs and Asymmetric Price Adjustment," CEPR Discussion Papers 5749, C.E.P.R. Discussion Papers.
    17. Daniel Levy & Haipeng (Allan) Chen & Georg Müller & Shantanu Dutta & Mark Bergen, 2010. "Holiday Price Rigidity and Cost of Price Adjustment," Economica, London School of Economics and Political Science, pages 172-198.
    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. Per Krusell & Anthony A. Smith, Jr., 1999. "On the Welfare Effects of Eliminating Business Cycles," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, pages 245-272.
    20. Sam Peltzman, 2000. "Prices Rise Faster than They Fall," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 466-502, June.
    21. 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.
    22. Per Krusell & Anthony A. Smith & Jr., 1998. "Income and Wealth Heterogeneity in the Macroeconomy," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 867-896, October.
    23. Peter J. Klenow & Jonathan L. Willis, 2016. "Real Rigidities and Nominal Price Changes," Economica, London School of Economics and Political Science, vol. 83(331), pages 443-472, July.
    24. James Peery Cover, 1992. "Asymmetric Effects of Positive and Negative Money-Supply Shocks," The Quarterly Journal of Economics, Oxford University Press, vol. 107(4), pages 1261-1282.
    25. Morten O. Ravn & Martin Sola, 2004. "Asymmetric effects of monetary policy in the United States," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 41-60.
    26. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
    27. 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.
    28. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    29. Huanxing Yang & Lixin Ye, 2008. "Search with learning: understanding asymmetric price adjustments," RAND Journal of Economics, RAND Corporation, vol. 39(2), pages 547-564.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    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

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Chen Yeh & David Argente, 2016. "A Menu Cost Model with Price Experimentation," 2016 Meeting Papers 1515, Society for Economic Dynamics.
    2. Lanne Markku, 2015. "Noncausality and inflation persistence," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, pages 469-481.
    3. Jaccard Ivan, 2011. "Asset Pricing and Housing Supply in a Production Economy," The B.E. Journal of Macroeconomics, De Gruyter, pages 1-40.
    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, pages 161-182.
    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. Adam Reiff & Peter Karadi, 2011. "Large Shocks in Menu Cost Models," 2011 Meeting Papers 884, Society for Economic Dynamics.

    More about this item

    Keywords

    Inflation asymmetry; state-dependent pricing; time-dependent pricing; value-added tax shock;

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ecb:ecbwps:20121453. 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). General contact details of provider: http://edirc.repec.org/data/emieude.html .

    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 CitEc recognized a reference but did not link an item in RePEc 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 RePEc Author Service 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.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.