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Prices are Sticky After All

  • Patrick J. Kehoe
  • Virgiliu Midrigan

Recent studies say prices change every four months. Economists have interpreted this high frequency as evidence against the importance of sticky prices for the monetary transmission mechanism. Theory implies that if most price changes are regular, as they are in the standard New Keynesian model, then this interpretation is correct. But, if most price changes are temporary, as they are in the data, then it is incorrect. Temporary changes have two striking features: after a change, the nominal price returns exactly to its pre-existing level, and temporary changes are clustered in time. Our model, which replicates these features, implies that temporary changes cannot offset monetary shocks well, whereas regular changes can. Since regular prices are much stickier than temporary ones, our model, in which prices change as frequently as they do in the micro data, predicts that the aggregate price level is as sticky as in a standard model in which micro level prices change once every 12 months. In this sense, prices are sticky after all.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16364.

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Date of creation: Sep 2010
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Publication status: published as Patrick Kehoe & Virgiliu Midrigan, 2015. "Prices are sticky after all," Journal of Monetary Economics, vol 75, pages 35-53.
Handle: RePEc:nbr:nberwo:16364
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