Menu Costs, Aggregate Fluctuations and Large Shocks

Adam Reiff and Peter Karadi
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Peter Karadi: European Central Bank

No 914, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: In menu cost models, real effects of aggregate nominal shocks are sensitive to unobserved characteristics of price setting. The standard way to calibrate key pricing parameters is to match the cross-sectional distribution of price changes. We argue that this unconditional distribution contains insufficient information for a clean identification. In particular, it is consistent with parameterizations with contradictory aggregate implications: one generating sizeable real effects, the other effective money neutrality. We argue, instead, that price change observations conditional on aggregate shocks can be sufficiently informative. To show this, we utilize new micro level evidence on price responses to large value-added tax shocks. We present a new menu cost model with idiosyncratic shocks and show that our model successfully predicts the magnitude of the observed price responses, outperforming alternative pricing models. The new model generates small real effects of monetary policy shocks implying that imposing the menu cost assumption alone fails to explain robust time-series evidence finding the opposite.

Date: 2014
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (20)

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Related works:
Journal Article: Menu Costs, Aggregate Fluctuations, and Large Shocks (2019)
Working Paper: Menu Costs, Aggregate Fluctuations, and Large Shocks (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:914

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