State Dependent Pricing and Dynamics of Business Cycles

FRB Richmond Working Paper No. 97-2

49 Pages Posted: 19 Nov 2012

See all articles by Michael Dotsey

Michael Dotsey

Federal Reserve Bank of Philadelphia

Robert G. King

Boston University - Department of Economics; Federal Reserve Bank of Richmond - Research Department; National Bureau of Economic Research (NBER)

Alexander L. Wolman

Federal Reserve Bank of Richmond

Date Written: February 13, 1997

Abstract

The nature of price dynamics has long been thought important for the origin and duration of business cycles. To investigate this topic, we construct a dynamic stochastic general equilibrium macroeconomic model in which monopolistically competitive firms face fixed costs of changing the nominal prices of final goods. These prices are thus changed infrequently and discretely. The framework captures major features of the price dynamics stressed by the New Keynesian research program, particularly work on (s,S) pricing rules. However, by treating firms as heterogenous with respect to the size of fixed costs of price adjustment, we are able to study a wider range of issues than in the prior literature. For example, we explore how the nature of optimal price-setting depends on (i) the extent of persistence of variations in the money stock and (ii) the interest elasticity of money demand. Further, our model can be used to study a wide range of aspects of the positive and normative economics of monetary policy. We illustrate these topics by considering the consequences of changing the rate of inflation and by evaluating alternative policy rules.

Suggested Citation

Dotsey, Michael and King, Robert G. and Wolman, Alexander L., State Dependent Pricing and Dynamics of Business Cycles (February 13, 1997). FRB Richmond Working Paper No. 97-2. Available at SSRN: https://ssrn.com/abstract=2129996 or http://dx.doi.org/10.2139/ssrn.2129996

Michael Dotsey (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
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Robert G. King

Boston University - Department of Economics ( email )

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Boston, MA 02215
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617-353-5941 (Phone)

Federal Reserve Bank of Richmond - Research Department

P.O. Box 27622
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National Bureau of Economic Research (NBER)

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Alexander L. Wolman

Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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