Precautionary price stickiness

James S. Costain () and Anton A. Nakov

No 1122, Banco de España Working Papers from Banco de España

Abstract: This paper proposes two models in which price stickiness arises endogenously even though fi rms are free to change their prices at zero physical cost. Firms are subject to idiosyncratic and aggregate shocks, and they also face a risk of making errors when they set their prices. In our fi rst specifi cation, fi rms are assumed to play a dynamic logit equilibrium, which implies that big mistakes are less likely than small ones. The second specifi cation derives logit behavior from an assumption that precision is costly. The empirical implications of the two versions of our model are very similar. Since fi rms making suffi ciently large errors choose to adjust, both versions generate a strong “selection effect” in response to a nominal shock that eliminates most of the monetary nonneutrality found in the Calvo model. Thus the model implies that money shocks have little impact on the real economy, as in Golosov and Lucas (2007), but fi ts microdata better than their specifi cation.

Keywords: Nominal rigidity; logit equilibrium; state-dependent pricing; (S; s) adjustment; near-rational behavior (search for similar items in EconPapers)
JEL-codes: E31 D81 C72 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-com, nep-dge, nep-hme and nep-mac
Date: 2011-09
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Related works:
Working Paper: Precautionary price stickiness (2011)
Working Paper: Precautionary price stickiness (2010)
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Persistent link: http://EconPapers.repec.org/RePEc:bde:wpaper:1122

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