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Price Inertia and Inflation: Evidence and Theoretical Rationale

  • M. Ishaq Nadiri
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    In this paper we look at some empiricel evidence of and theoretical rationale for price inflexibility in the face of a decrease in short run demand in the Western-type industrialized economies. The empirical evidence suggests that price sluggishness is pervasive but varies across markets, industries and countries. There are different reasons for the price inertia. The response of firms to uncertainty, the cost of adjusting prices, the contents of the long- term contracts in the goods and input markets, the extent and variability of excess demand may differ among firms and industries. The structure of the industry, the degree of heterogeneity of the products in a market, the network of input-output relationship among industries, the nature of international competition, the process of forming expectations about the future, shocks from monetary and fiscal policies and input price shocks, all interact and create the ever changing environment of the firms. In these changing circumstances there are incentives for prices to be sluggish and thus arises the dilemma of achieving price stability at a high cost of unemployment. The ability of governments to achieve stable prices is probably endogenous in the system and may depend on a threshold rate of inflation. A number of policy options are discussed to address the issue of price inertia which would reduce the adjustment burden of anti-inflationary policies.

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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2022.

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    Date of creation: Sep 1986
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    Publication status: published as Nadiri, M.I. "Price Inertia and Inflation: Evidence and Theoretical Rationale," in Structural Change, Economic Interdependence and World Development , ed. by Luigi Pasinetti and Peter Lloyd, Vol. 3, Houndsmill and London: Macmillan, 1987, pp. 329-357.
    Handle: RePEc:nbr:nberwo:2022
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    1. Michael Bruno & Jeffrey Sachs, 1982. "Input Price Shocks and the Slowdown in Economic Growth: The Case of U.K.Manufacturing," NBER Working Papers 0851, National Bureau of Economic Research, Inc.
    2. Thomas J. Sargent, 1981. "The ends of four big inflations," Working Papers 158, Federal Reserve Bank of Minneapolis.
    3. Alan S. Blinder, 1981. "Inventories and Sticky Prices: More on the Microfoundations of Macroeconomics," NBER Working Papers 0620, National Bureau of Economic Research, Inc.
    4. Popkin, Joel, 1977. "An Integrated Model of Final and Intermediate Demand by Stage of Process: A Progress Report," American Economic Review, American Economic Association, vol. 67(1), pages 141-47, February.
    5. Hay, George A, 1970. "Production, Price, and Inventory Theory," American Economic Review, American Economic Association, vol. 60(4), pages 531-45, September.
    6. Wachter, Michael L, 1976. "Some Problems in Wage Stabilization," American Economic Review, American Economic Association, vol. 66(2), pages 65-71, May.
    7. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    8. Olivier J. Blanchard, 1982. "Price Asynchronization and Price Level Inertia," NBER Working Papers 0900, National Bureau of Economic Research, Inc.
    9. Kuran, Timur, 1983. "Asymmetric Price Rigidity and Inflationary Bias," American Economic Review, American Economic Association, vol. 73(3), pages 373-82, June.
    10. Robert J. Gordon, 1980. "A Consistent Characterization of a Near-Century of Price Behavior," NBER Working Papers 0455, National Bureau of Economic Research, Inc.
    11. Maccini, Louis J, 1981. "Adjustment Lags, Economically Rational Expectations and Price Behavior," The Review of Economics and Statistics, MIT Press, vol. 63(2), pages 213-22, May.
    12. Stephen A. Ross & Michael L. Wachter, 1975. "Pricing and Timing Decisions in Oligopoly Industries," The Quarterly Journal of Economics, Oxford University Press, vol. 89(1), pages 115-137.
    13. repec:oup:restud:v:49:y:1982:i:5:p:679-705 is not listed on IDEAS
    14. Louis Phlips, 1980. "Intertemporal Price Discrimination and Sticky Prices," The Quarterly Journal of Economics, Oxford University Press, vol. 94(3), pages 525-542.
    15. repec:oup:restud:v:49:y:1982:i:4:p:517-31 is not listed on IDEAS
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