Product Turnover and Endogenous Price Flexibility in Uncertain Times

Abstract

Price setting has become more flexible following a string of large adverse shocks (COVID-19, the Ukraine War). We argue that a shift to a high-uncertainty regime incentivizes firms to invest in their ability to adjust prices. We formalize this idea in a general equilibrium model with endogenous price flexibility and entry-exit. Faced with higher productivity uncertainty, firms set prices more flexibly. This improves their resilience, reducing exit and output losses in response to negative supply shocks. Uncertainty regarding monetary policy has similar effects. We show that higher monetary policy uncertainty can be welfare-improving when productivity shocks are large.

Keywords: entry, exit, price flexibility, supply shocks, uncertainty

JEL Classification: E22, E31, E32