Working Paper: NBER ID: w28654
Authors: Makoto Nirei; Jos A. Scheinkman
Abstract: We present a menu-cost pricing model with a large but finite number n of firms. A firm’s nominal price increase lowers other firms’ relative prices, thereby inducing further nominal price increases. The distribution of these repricing avalanches converges as n→∞ to a mixture of Generalized Poisson Distributions (GPD), with an index of dispersion (variance/mean) that is a function of a single variable θ that is determined by the equilibrium of the continuous limit. The index of dispersion explodes as θ→1. We calibrate the model to the U.S. experience during 1988–2005 and obtain a θ surprisingly close to unity. Simulations show that a GPD fits well the distribution of avalanches but that, once we account for the dynamics, the multiplier effect derived from a firm adjusting prices by paying menu costs is even larger. We also show that the model can account for the positive relationship between inflation level and volatility that was observed in 1988–2005 in the U.S.
Keywords: menu costs; inflation volatility; price changes; generalized Poisson distribution
JEL Codes: E31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| firm A's price increase (L11) | firm B's pricing behavior (L11) |
| firm B's pricing behavior (L11) | further price increases (P22) |
| number of firms adjusting prices (L11) | aggregate price volatility (C43) |
| inflation levels (E31) | volatility (E32) |