Working Paper: CEPR ID: DP10138
Authors: Peter Karadi; Adam Reiff
Abstract: How do frictions in price setting influence monetary non-neutrality? We revisit this classic question in a quantitative menu cost model with multi-product firms that face idiosyncratic shocks with unsynchronized stochastic volatility. The model matches the unconditional distribution of price changes and successfully predicts new evidence on pricing responses to large value-added tax shocks. In particular, it captures both the exploding fraction of price changes and the shape of their conditional distribution, outperforming alternative models. The model generates near money neutrality even to small nominal shocks.
Keywords: monetary policy; transmission; price change distribution; state dependent pricing; value-added tax
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher menu costs (D49) | reduced price flexibility (L11) |
| reduced price flexibility (L11) | mitigated real effects of nominal shocks (E39) |
| small fixed menu costs (D41) | staggered price setting (P22) |
| staggered price setting (P22) | influences impact of nominal shocks on economic activity (F41) |
| high menu costs (D40) | discourage small price changes (D41) |
| larger desired price changes (E31) | more likely to adjust prices (D40) |
| price adjustments (L11) | disproportionate response of price level to aggregate shocks (E30) |
| shape of idiosyncratic shock distribution (D39) | affects conclusions regarding money neutrality (E49) |
| distribution of price changes following nominal shocks (E39) | insights into underlying idiosyncratic shock distribution (D39) |