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Price stickiness in Ss models: new interpretations for old results

Author

Listed:
  • Eduardo Engel

    (Yale)

  • Ricardo Caballero

    (MIT)

Abstract

What is the relation between infrequent price adjustment and the dynamic response of the aggregate price level to monetary shocks? The answer to this question ranges from a one-to-one link (Calvo, 1983) to no connection whatsoever (Caplin and Spulber, 1987). The purpose of this paper is to provide a unified framework to understand the mechanisms behind this wide range of results. In doing so, we provide new interpretations of key results in this area. In particular, when price stickiness is measured in terms of the impulse response function, the monetary neutrality result of Caplin and Spulber is not a consequence of aggregation, as is often assumed, but is due instead to properties of the microeconomic impulse response function. We also show that the ”selection effect,” according to which units that adjust their prices are those that benefit the most, is an important feature of Ss-type models but is neither necessary nor sufficient to account for the higher aggregate flexibility of these models compared to Calvo models. Instead, the key concept is the contribution of the extensive margin of adjustment to the aggregate price response. The aggregate price level is more flexible than suggested by the microeconomic frequency of adjustment if and only if this term is positive.

Suggested Citation

  • Eduardo Engel & Ricardo Caballero, 2007. "Price stickiness in Ss models: new interpretations for old results," 2007 Meeting Papers 903, Society for Economic Dynamics.
  • Handle: RePEc:red:sed007:903
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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