Setting the Right Prices for the Wrong Reasons

55 Pages Posted: 9 Nov 2018

See all articles by Christian Hellwig

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE)

Venky Venkateswaran

New York University (NYU) - Leonard N. Stern School of Business; Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Date Written: June 16, 2009

Abstract

Nominal price adjustment is studied in an environment with firm-specific and aggregate shocks to economic fundamentals and incomplete, dispersed information. Firms update their expectations about fundamentals based on their own cash flows (revenues and wages). We show that in a model with realistic levels of product-level price dispersion, the firms’ inference about aggregate shocks is very gradual, yet in the aggregate prices adjust rapidly in response to aggregate nominal shocks. When an aggregate shock occurs, firms mistakenly attribute it to firm-specific shocks, but adjust prices nevertheless, since the exact nature of the shock matters little for their optimal pricing decision.

Keywords: Real Effects of Nominal Shocks, Price Setting, Incomplete Information

JEL Classification: E31, E32, D82

Suggested Citation

Hellwig, Christian and Venkateswaran, Venky, Setting the Right Prices for the Wrong Reasons (June 16, 2009). Journal of Monetary Economics, Vol. 56, 2009. Available at SSRN: https://ssrn.com/abstract=3267589

Christian Hellwig

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Venky Venkateswaran (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

Suite 9-160
New York, NY
United States

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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