Working Paper: NBER ID: w14184
Authors: Yuriy Gorodnichenko
Abstract: This paper develops a model where firms make state-dependent decisions on both pricing and acquisition of information. It is shown that when information is not perfect, menu costs combined with the aggregate price level serving as an endogenous public signal generate rigidity in price setting even when there is no real rigidity. Specifically, firms reveal their information to other firms by changing their prices. Because the cost of changing price is borne by a firm but the benefit from better information goes to other firms, firms have an incentive to postpone price changes until more information is revealed by other firms via the price level. The information externality and menu costs reinforce each other in delaying price adjustment. As a result, the response of inflation to nominal shocks is both sluggish and hump-shaped. The model can also qualitatively capture a number of stylized facts about price setting at the micro level and inflation at the macro level.
Keywords: menu costs; inflation persistence; information acquisition; price setting
JEL Codes: D82; D83; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| menu costs + aggregate price level (E30) | price rigidity (D41) |
| aggregate price level (E30) | firms' decisions on price adjustments (L11) |
| firms' decisions on price adjustments (L11) | sluggish inflation responses to nominal shocks (E31) |
| information externality (D62) | delay in price adjustments (E31) |
| menu costs + information externality (H49) | delay in price adjustments (P22) |
| delay in price adjustments (E31) | prolonged inflation persistence (E31) |
| menu costs (E64) | information acquisition (D83) |
| information acquisition (D83) | price rigidity (D41) |