Sticky Prices, Coordination and Enforcement

24 Pages Posted: 22 Sep 2003

See all articles by John C. Driscoll

John C. Driscoll

Board of Governors of the Federal Reserve System

Harumi Ito

National Bureau of Economic Research (NBER)

Date Written: 2003

Abstract

Price-setting models with monopolistic competition and costs of changing prices exhibit coordination failure: in response to a monetary policy shock, individual agents lack incentives to change prices even when it would be Pareto-improving if all agents did so. The potential welfare gains are in part evaluated relative to a benchmark equilibrium of perfect, costless coordination; in practice, since agents will still have incentives to deviate from the benchmark equilibrium, coordination is likely to require enforcement. We consider an alternative benchmark equilibrium in which coordination is enforced by punishing deviators. This is formally equivalent to modeling agents as a cartel playing a punishment game. We show that this new benchmark implies that the welfare losses from coordination failure are smaller. Moreover, at the new benchmark equilibrium, prices are upwards-flexible but downwards-sticky. These last results suggest that the dynamic behavior of sticky-price models may more generally depend on the kind of imperfect competition assumed.

Keywords: Coordination failure, menu costs, monopolistic competition

JEL Classification: D43, E12, E30, L13

Suggested Citation

Driscoll, John C. and Ito, Harumi, Sticky Prices, Coordination and Enforcement (2003). Available at SSRN: https://ssrn.com/abstract=436582 or http://dx.doi.org/10.2139/ssrn.436582

John C. Driscoll (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/john-c-driscoll.htm

Harumi Ito

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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