Information Acquisition and Price Setting under Uncertainty: New Survey Evidence

Cheng Chen, Tatsuro Senga, Chang Sun and Hongyong Zhang

Discussion papers from Research Institute of Economy, Trade and Industry (RIETI)

Abstract: What makes prices sticky? While it is commonly understood that prices adjust only sluggishly to changes in economic conditions, the cause of sluggish price adjustment is underexplored empirically. In this paper, we argue that sluggish updating of information drives price stickiness. To this end, we use a panel dataset that contains information on both firm-level expectations and price adjustments and document the following facts: (1) there is a positive correlation between whether a firm updates its expectations and whether it adjusts prices; (2) firms update expectations more frequently and make less correlated forecast errors in downturns; and (3) firms adjust prices more frequently in downturns. We then extend an Ss price-setting model with second moment shocks to allow for endogenous information acquisition by the firm. The model predicts that firms acquire information more intensively during periods of high volatility, also adjusting expectations and prices more often. Countercyclical volatility, interacting with menu costs and information rigidity, is what drives our results. This implies that the flexibility of the aggregate price level is counter-cyclical, making monetary policy less effective in recessions.

Pages: 52 pages
Date: 2020-10
New Economics Papers: this item is included in nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:eti:dpaper:20078

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