Precautionary price stickiness

James S. Costain () and Anton A. Nakov

No 1375, Working Paper Series from European Central Bank

Abstract: This paper proposes two models in which price stickiness arises endogenously even though firms 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 first specification, firms are assumed to play a dynamic logit equilibrium, which implies that big mistakes are less likely than small ones. The second specification derives logit behavior from an assumption that precision is costly. The empirical implications of the two versions of our model are very similar. Since firms making sufficiently 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 fits microdata better than their specification. JEL Classification: E31, D81, C72.

Keywords: Logit equilibrium; state-dependent pricing; (S; s) adjustment; near rationality; information-constrained pricing. (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-com, nep-dge and nep-mac
Date: 2011-08
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (1) Track citations by RSS feed

Downloads: (external link)
http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1375.pdf (application/pdf)

Related works:
Working Paper: Precautionary price stickiness (2011)
Working Paper: Precautionary price stickiness (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:ecb:ecbwps:20111375

Ordering information: This working paper can be ordered from
Press and Information Division, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank
Address: Postfach 16 03 19, Frankfurt am Main, Germany
Contact information at EDIRC.
Series data maintained by Official Publications ().