Working Paper: NBER ID: w12945
Authors: Ricardo J. Caballero; Eduardo M. R. Engel
Abstract: What is the relation between infrequent price adjustment and the dynamic response of the aggregate price level to monetary shocks? The answer to this question ranges from a one-to-one link (Calvo, 1983) to no connection whatsoever (Caplin and Spulber, 1987). The purpose of this paper is to provide a unified framework to understand the mechanisms behind this wide range of results. In doing so, we propose new interpretations of key results in this area, which in turn suggest the kind of Ss model that is likely to generate substantial price rigidity. The first result we revisit is Caplin and Spulber's monetary neutrality model. We show that when price stickiness is measured in terms of the impulse response function, this result is not a consequence of aggregation, but is due instead to the absence of price-stickiness at the microeconomic level. We also show that the "selection effect," according to which units that adjust their prices are those that benefit most, is neither necessary nor sufficient to account for the higher aggregate flexibility of Ss-type models compared to Calvo models. Instead, the key concept is the contribution of the extensive margin of adjustment to the aggregate price response. The aggregate price level is more flexible than suggested by the microeconomic frequency of adjustment if and only if this term is positive.
Keywords: Price Stickiness; Monetary Shocks; Microeconomic Adjustment; Aggregate Price Level
JEL Codes: E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| microeconomic price stickiness (D41) | aggregate price level's response to monetary shocks (E39) |
| absence of microeconomic price stickiness (D41) | aggregate price level's response to shocks is neutral (E30) |
| extensive margin of adjustment (F16) | aggregate price response (C43) |
| micro-level adjustments (D00) | macroeconomic outcomes (E66) |
| fraction of agents adjusting their prices (L11) | aggregate price response to monetary impulses (E19) |
| selection effect is neither necessary nor sufficient (C52) | higher aggregate price level response compared to Calvo model (E19) |
| aggregate price level flexibility (E30) | microeconomic frequency of adjustment (D00) |