Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty

Cosmin Ilut, Rosen Valchev and Nicolas Vincent

No 22490, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We propose a new theory of price rigidity based on firms’ Knightian uncertainty about their competitive environment. This uncertainty has two key implications. First, firms learn about the shape of their demand function from past observations of quantities sold. This learning gives rise to kinks in the expected profit function at previously observed prices, making those prices both sticky and more likely to reoccur. Second, uncertainty about the relationship between aggregate and industry-level inflation generates nominal rigidity. We prove the main insights analytically and quantify the effects of our mechanism. Our estimated quantitative model is consistent with a wide range of micro-level pricing facts that are typically challenging to match jointly. It also implies significantly more persistent monetary non-neutrality than in standard models, allowing it to generate large real effects from nominal shocks.

JEL-codes: C1 D8 E3 L11 (search for similar items in EconPapers)
Date: 2016-08
New Economics Papers: this item is included in nep-com, nep-hme, nep-mac and nep-mic
Note: EFG IO ME
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (17)

Published as Cosmin Ilut & Rosen Valchev & Nicolas Vincent, 2020. "Paralyzed by Fear: Rigid and Discrete Pricing Under Demand Uncertainty," Econometrica, Econometric Society, vol. 88(5), pages 1899-1938, September.

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Related works:
Working Paper: Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty (2016)
Working Paper: Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty (2014)
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