Monetary Shocks in a Model with Inattentive Producers

Abstract

We study a model in which prices respond slowly to shocks because firms must pay a fixed cost to observe the determinants of the profit maximizing price, as pioneered by Caballero (1989) and Reis (2006). We extend their analysis to the case of random tran- sitory variation in the firm’s observation cost and characterize the mapping from the distribution of observation cost to the distribution of the times between consecutive re- views/price adjustments of a firm. We aggregate a continuum of firms and characterize analytically the cross-sectional distribution of the duration of reviews/prices. We establish the dependence of the real effect of a monetary shock on the distribution of price durations and hence on the distribution of observation costs and discuss applications.

Keywords: impulse responses., inattentiveness, monetary shocks, observation costs

JEL Classification: E5