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Dynamic Pricing and Imperfect Common Knowledge

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  • Kristoffer Nimark

    (Reserve Bank of Australia)

Abstract

This paper introduces private information into the dynamic pricing decision of firms in an otherwise standard new Keynesian model by adding an idiosyncratic component to firms’ marginal costs. The model can then replicate two stylised facts about price changes: aggregate inflation responds gradually and with inertia to shocks, while at the same time price changes of individual goods can be quite large. The inertial behaviour of inflation is driven by privately informed firms strategically ‘herding’ on the public information contained in the observations of lagged aggregate variables. The model also matches the average duration between price changes found in the data and it nests the standard new Keynesian Phillips curve as a special case. To solve the model, the paper derives an algorithm for solving a class of dynamic models with higher-order expectations.

Suggested Citation

  • Kristoffer Nimark, 2007. "Dynamic Pricing and Imperfect Common Knowledge," RBA Research Discussion Papers rdp2007-12, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp2007-12
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    File URL: https://www.rba.gov.au/publications/rdp/2007/pdf/rdp2007-12.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    higher-order expectations; idiosyncratic marginal cost; price dynamics; new Keynesian Phillips curve;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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