Coarse Pricing Policies

Abstract

The muted volatility of inflation during the Great Recession and its aftermath has refocused attention on the constraints that firms face when adjusting prices. Using new empirical and theoretical results, I argue that each firm's choice of how much information to acquire to set prices plays a central role in determining the patterns of pricing at the product-level and the degree of aggregate price rigidity in response to shocks. In support of the information channel, I present product-level evidence that firms price goods using coarse pricing policies that are updated infrequently and consist of a small menu of prices. Firms are heterogeneous in the complexity and duration of their pricing policies, and this heterogeneity is reflected in differential responses to the Great Recession cycle, with firms exhibiting more complex policies responding more aggressively. I develop a theory of information-constrained price setting that generates coarse pricing endogenously, and quantitatively matches the discreteness, duration, and volatility of policies in the data. The information friction dampens the responsiveness of prices to shocks, and, coupled with heightened volatility, induces firms to keep prices relatively high, to protect against losses in an uncertain environment.

Keywords: Inflation Puzzle, Great Recession, Discrete Prices, Rational Inattention, Nominal Rigidities

JEL Classification: E3, E5