Optimally Sticky Prices

William Zame and Jean-Paul L'Huillier

No 621, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: We propose a microfoundation for sticky prices. We consider a an environment in which a monopolistic firm has better information than its consumers about the nominal aggregate state. We show that, when many consumers are uninformed (and for some ranges of parameters), it is optimal for the firm to offer contracts/prices that do not depend on the state of the world; i.e. optimal contracts/prices are sticky. We establish this result first in a general mechanism design framework that allows for non-linear pricing and screening, and then show implementation under both contract-setting and price-setting. A virtue of our microfoundation is that it is compatible with a dynamic general equilibrium model with money. We analyze whether money is neutral in this framework, and discuss the implications of this microfounded friction for welfare.

Date: 2015
New Economics Papers: this item is included in nep-dge
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