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Price plans and the real effects of monetary policy

Fernando Alvarez and Francesco Lippi
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Fernando Alvarez: University of Chicago

No 1609, EIEF Working Papers Series from Einaudi Institute for Economics and Finance (EIEF)

Abstract: We analyze a sticky price model where a firm chooses a price plan, namely a set of 2 prices. Changing the plan entails a “menu cost”, but either price in the plan can be charged at any point in time. We analytically solve for the optimal policy and for the output response to a monetary shock. The setup generates a persistent reference price level and short lived deviations from it, as well as a decreasing hazard function for price changes, consistent with some datasets. We show that the temporary price changes substantially increase the flexibility of the aggregate price level.

New Economics Papers: this item is included in nep-cba and nep-mon
Date: 2016, Revised 2016-05
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