Pitfalls in the Modeling of Forward-Looking Price Setting and Investment Decisions

UPF Economics and Business Working Paper 773

22 Pages Posted: 15 Nov 2005

See all articles by Lutz Weinke

Lutz Weinke

Independent

Tommy Sveen

Norges Bank - Research Department

Date Written: September 10, 2004

Abstract

The present paper makes progress in explaining the role of capital for inflation and output dynamics. We followWoodford (2003, Ch. 5) in assuming Calvo pricing combined with a convex capital adjustment cost at the firm level. Our main result is that capital accumulation affects inflation dynamics primarily through its impact on the marginal cost. This mechanism is much simpler than the one implied by the analysis in Woodford's text. The reason is that his analysis suffers from a conceptual mistake, as we show. The latter obscures the economic mechanism through which capital affects inflation and output dynamics in the Calvo model, as discussed in Woodford (2004).

Keywords: Sticky Prices, Investments

JEL Classification: E22, E31

Suggested Citation

Weinke, Lutz and Sveen, Tommy, Pitfalls in the Modeling of Forward-Looking Price Setting and Investment Decisions (September 10, 2004). Available at SSRN: https://ssrn.com/abstract=848505 or http://dx.doi.org/10.2139/ssrn.848505

Lutz Weinke (Contact Author)

Independent

No Address Available

Tommy Sveen

Norges Bank - Research Department ( email )

P.O. Box 1179
Oslo, N-0107
Norway

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