Price Adjustments in a General Model of State-Dependent Pricing

43 Pages Posted: 24 Nov 2008 Last revised: 2 Dec 2008

See all articles by James S. Costain

James S. Costain

Banco de España - Research Department

Anton Nakov

European Central Bank (ECB); CEPR

Date Written: November 21, 2008

Abstract

In this paper, we show that a simple model of smoothly state-dependent pricing generates a distribution of price adjustments similar to that observed in microeconomic data, both for low and high inflation. Our setup is based on one fundamental assumption: price adjustment is more likely when it is more valuable. The constant probability model (Calvo 1983) and the fixed and stochastic menu cost models (Golosov and Lucas 2007; Dotsey, King and Wolman 1999) are nested as special cases of our framework.

All parameterizations of our model can be ranked according to a measure of state dependence. The fixed menu cost model has the highest possible degree of state dependence; the parameterization which best fits US microdata has low state dependence. The fixed menu cost model is inconsistent with the evidence both because it never generates small price adjustments, and because it implies a large fall in the standard deviation of price adjustments as trend inflation increases. Even though the state dependence of our preferred parameterization is almost as low as that of the Calvo model, it is well-behaved when we change the steady state inflation rate, matching the data at least as well as Golosov and Lucas' model.

Keywords: price stickiness, state-dependent pricing, stochastic menu costs, generalized (S,s), bounded rationality

JEL Classification: E31, D81

Suggested Citation

Costain, James S. and Nakov, Anton A., Price Adjustments in a General Model of State-Dependent Pricing (November 21, 2008). Banco de Espana Working Paper No. 0824, Available at SSRN: https://ssrn.com/abstract=1305168 or http://dx.doi.org/10.2139/ssrn.1305168

James S. Costain (Contact Author)

Banco de España - Research Department ( email )

Alcala 50
28014 Madrid
Spain

Anton A. Nakov

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

CEPR ( email )

London
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
39
Abstract Views
534
PlumX Metrics