Pitfalls in the modeling of forward-looking price setting and investment decisions

Tommy Sveen () and Lutz Weinke

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: The present paper makes progress in explaining the role of capital for inflation and output dynamics. We followWoodford (2003, Ch. 5) in assuming Calvo pricing combined with a convex capital adjustment cost at the firm level. Our main result is that capital accumulation affects inflation dynamics primarily through its impact on the marginal cost. This mechanism is much simpler than the one implied by the analysis in Woodford's text. The reason is that his analysis suffers from a conceptual mistake, as we show. The latter obscures the economic mechanism through which capital affects inflation and output dynamics in the Calvo model, as discussed in Woodford (2004).

Keywords: Sticky prices; investments (search for similar items in EconPapers)
JEL-codes: E22 E31 (search for similar items in EconPapers)
Date: 2004-09
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (30)

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