Even if price are slow to adjust, this no necessarily median that monetary policy have the right to be used to wake up or slow economic activity



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Executive an overview

many economists think that prices room “sticky”—they readjust slowly. This stickiness, they suggest, means that changesin the money supply have an influence on the real economy, inducing alters in investment, employment, output and consumption, an effect that have the right to be exploited by policymakers.

In this essay, we argue that price stickiness doesn’t necessarily create an exploitable policy option. We define a model in which money is neutral (that is, expansion or reduction in moneysupply doesn’t impact real economic activity) even in a paper definition of slow price adjustment.


right here are 2 venerable concerns in macroeconomic theory and also policy analysis: room prices sticky? Does the matter?

by “sticky” prices, we mean the observation that some sellers collection prices in nominal terms that do not adjust quickly in response to alters in the aggregate price level or to changes in economic conditions much more generally. Part macroeconomics together taught in the classroom and also used in practice makes the presumption that nominal prices space sticky and then proceeds come derive policy implications. In this essay, we desire to challenge the idea that these policy effects are necessarily exactly (even if prices are sticky).

timeless macroeconomics embodied the idea the money is neutral—that is, enhancing or diminish the amount of money in an economic climate has no affect on genuine economic activity such together investment, production, consumption or hiring. If money is neutral, that is no clear what monetary policy can do.1

Some economists dispute classic neutrality. Castle argue the nominal prices room sticky, at the very least in the brief run, and that this has far-reaching consequences because that the real economy.2 The exact consequences depend on details, but many models that this college of thought have this effect: If buyers have more money and also sellers save their prices the same, the previous will demand an ext goods and also services and also the last (by assumption) will supply them. This generates rise in investment, employment, output and consumption.

The counterargument is the putting an ext cash in people’s hand is like including a zero to every bill; that is, a one-dollar bill becomes a 10-dollar bill, a 10 i do not care a 100 and so on. Some economic experts say the this ought not have actually a genuine impact, any much more than changing the means temperature is measured native Fahrenheit come Celsius would—it’s just units!

numerous economists allude out, however, that difficult prices are what us observe empirically and, indeed, there is an aspect of truth in their debate (see Klenow and also Malin 2010 for a survey of empirical work). Then we might ask, why do some sellers set prices in nominal state that carry out not readjust in an answer to changes in financial conditions? This appears to fly in the confront of elementary financial theory. Shouldn’t every seller have actually a distinctive target family member price, depending upon real factors, for this reason that as soon as the accumulation price level rises due to an increase in the money supply, every seller have to adjusts his or her nominal price by the exact same amount?

In plenty of popular macro models, consisting of those used by most policymakers, prices space sticky by assumption, in the sense that there are either limitations on how often they deserve to change, adhering to Taylor (1980) or Calvo (1983), or there are real resource costs to an altering them, complying with Rotemberg (1982) or Mankiw (1985). The is true in principle the a cost is occurs in an altering a price—the so-called food selection cost—even if this price is merely a piece of chalk. A notable attribute of these models, though, is the at their core they need a cost only for price changes, but ignore all various other potential transaction prices such as transforming one’s quantity, password, clothes or mind. Or they just impose through decree the a seller can readjust price just at a few points in time determined by pure chance.

Stickiness as a result, not assumption

here we explain a concept that generates price stickiness together a result, not an assumption, also if sellers can adjust price anytime they prefer at no cost. But in strong contrast v theories assuming difficult prices, this theory indicates that money is neutral, so a main bank cannot technician a boom or finish a slump just by printing currency. Our key goal in explicate this theory is not, however, simply to establish that prices are sticky or the money is neutral. Rather, our allude is that the observation of sluggish price mediate does no logically imply that money is nonneutral. Nor does it suggest that we require to focus predominately ~ above macro models the incorporate menu prices or associated devices.3

In two recent papers, Head et al. (2012) and also Liu et al. (2014), we propose straightforward models v the following features. Because of frictions in credit, consisting of lack the commitment and also imperfect monitoring or document keeping, buyers sometimes should use money. (This part of the concept is based upon Lagos and also Wright 2005.4) for the industry in which buyers and also sellers trade, us borrow the standard model the frictional great markets occurred by Burdett and Judd (1983). That model, based upon search frictions, delivers price dispersion and also has proved helpful in plenty of other applications, including the big literature on labor markets following Burdett and also Mortensen (1998).5

To understand the Burdett-Judd model, it help to first review the earliest search models, wherein buyers sampled sellers sequentially until they uncovered one offering at a price below the highest possible price buyers were willing to pay. Burdett and also Judd change Diamond’s (1971) classic search model, which, problematically, had no price dispersion.6 Burdett and also Judd’s one (ostensibly minimal) readjust to the Diamond design is this: fairly than sampling prices one in ~ a time, together Diamond had actually it, buyers in the Burdett-Judd model have actually a positive probability that sampling two or much more prices at the very same time. If every sellers set the very same price, a buyer is indifferent to selecting one end another and also must use some tie-breaking rule to pick. This, of course, provides an individual seller a vast incentive to cut his or her price to acquire the sale. In fact, Burdett and also Judd uncover that, in the model’s equilibrium, every sellers charge various prices: price dispersion.

when Burdett-Judd pricing is installed into a financial model, sellers write-up prices in dollars, since this is how buyers room paying. At any date, over there is a variety of post prices for which sellers will obtain the very same profit. If the version pins under the circulation of prices, the does not set the price for any kind of individual seller. Why not? A low price generates much less profit per sale, but makes increase for the low profit generation through sales volume, since a sale is more likely from any buyer who samples a short price.

If the money supply increases, the equilibrium price circulation shifts up, however this new distribution can overlap through the previous selection of prices. This way that some (but no all) sellers must adjust their prices. If an individual seller’s price falls external the selection of prices the sellers will certainly charge after the boost of money supply, it need to adjust; yet if it is quiet in the variety of new prices, it might not.

Now, remind the concern posed earlier: Shouldn’t every seller have a target actual price and, therefore, as soon as the money supply increases, shouldn’t every seller change his or she nominal price through the very same amount? The price is no. Sellers perform not have actually a unique target price. The model’s equilibrium needs a circulation of prices, every one of which yield the exact same profit. If sellers perform not change their price once money it is provided increases, they certainly earn much less profit per unit, but again they make it increase on the volume. Hence, sellers can adjust prices infrequently in the challenge of constant movements in economic conditions, also though castle are enabled to readjust whenever they favor at no cost.

however the critical point is this: policy cannot manipulate this price stickiness due to the fact that the circulation of relative prices is pinned under uniquely. The level that the money supply and the accumulation price level are irrelevant—it is just a choice of units. This is classical neutrality.


Our allude is that money is not necessarily nonneutral just since prices are sticky. Moreover, a calibrated version of the design can match quite fine the empirical habits of price changes. These points space not widely well-known (or accepted, by those who are aware of them). Ball and also Mankiw (1994), to carry out a see representative the a broad segment the the business economics profession, say: “Sticky prices provide the most organic explanation of financial nonneutrality due to the fact that so numerous prices are, in fact, sticky.” castle add, moreover, that “based ~ above microeconomic evidence, we think that slow price mediate is the finest explanation for monetary nonneutrality,” and also “as a matter of logic, in the name of stickiness needs a price of nominal adjustment.”7

We translate these claims by Ball and also Mankiw to contain 3 points related, respectively, come empirics, theory and also policy, and our responses come the claims encapsulate our argument concerning monetary neutrality, or lack thereof.

Their very first claim is that price stickiness is a fact. Us agree.

Their second claim is that price stickiness implies “as a matter of logic” the existence of some technical constraints to price adjustment. The theory outlined over proves this dorn by displaying equilibria that enhance not just the broad observation that stickiness, yet the comprehensive empirical findings, v no together constraints.

Their third claim is the stickiness implies that money is not neutral and also that this justifies specific policy prescriptions. This is again verified wrong. The concept we’ve just discussed is continuous with the relevant observations, however money is neutral. Thus, difficult prices carry out not constitute definitive evidence that money is nonneutral or that certain policy recommendations are warranted.


1 come state this notion with straightforward math: intend the economic climate starts in one equilibrium with money it is provided M, nominal price level P and real assignment (consumption, investment, employment and so on) X. Then change M to M′. Over there is now an equilibrium with price level P′, in i beg your pardon M′/P′=M/P and X is unchanged. Hence, the readjust in M has actually no effect on something real.

2 proclaimed mathematically: when M alters to M′, the is not feasible for p to readjust to P′ at the very least in the quick run. Therefore M/P will not stay the same, and also that has real after-effects for X.

3 Our argument is somewhat analogous to that made by Robert Lucas in his well known 1972 paper. He defines a model consistent with the empirical observation that there is a optimistic correlation between the accumulation price level (or money supply) and output (or employment), but policymakers in this model cannot systematically exploit the relationship: raising inflation by printing money at a much faster rate will not increase average output or employment. Similarly, we argue that one can design a model continual with observations worrying nominal price adjustment, however it is not feasible for policymakers come systematically exploit this.

4 watch Lagos et al. (2015) because that a recent survey the the literature on monetary financial theory.

5 view Mortensen and Pissarides (1999) because that a inspection of this literature.

6 In Diamond’s model, firms article prices, bring away as given the price of others, and then buyers find as defined above. This design doesn’t generate price dispersion—problematic for a theory relying on buyers and sellers searching for one another. This finding set off a wave of research to generate endogenous price dispersion.

7 somewhat similarly, Golosov and Lucas (2003) say the “menu prices are really there: The truth that numerous individual items prices remain fixed for weeks or month in the challenge of continuously transforming demand and supply conditions testifies conclusively come the existence of a fixed cost of repricing.” Our allude here is no to pick on any specific individuals, but to provide some representative views in the profession.


Ball, L., and also N. Mankiw. 1994. “A Sticky-Price Manifesto.” Working file 4677. Nationwide Bureau of financial Research.

Burdett, K., and also K. Judd. 1983. “Equilibrium Price Dispersion.” Econometrica 51, 955-69.

Burdett, K., and D. Mortensen. 1998. “Wage Differentials, employee Size, and Unemployment.” International economic Review 39, 257-73.

Calvo, G. 1983. “Staggered price in a Utility-Maximizing Framework.” Journal of monetary Economics 12, 383-98.

Diamond, P. 1971. “A model of Price Adjustment.” Journal of economic Theory 2, 156-68.

Golosov, M., and R. Lucas. 2003. “Menu Costs and Phillips Curves.” Working file 10187. National Bureau of financial Research.

Head, A., L. Liu, G. Menzio and also R. Wright. 2012. “Sticky Prices: A new Monetarist Approach.” Journal of european Economic Association 10, 939-73.

Klenow, P., and B. Malin. 2010. “Microeconomic proof on Price-Setting.” In Handbook of monetary Economics, B. Friedman and also M. Woodford, eds.

Lagos, R., G. Rocheteau and also R. Wright. 2015. “Liquidity: A new Monetarist Perspective.” Journal of economic Literature, forthcoming.

Lagos, R., and R. Wright. 2005. “A Unified framework for financial Theory and Policy Analysis.” Journal of political Economy 113, 463-84.

Liu, L., L. Wang and also R. Wright. 2014. “Costly Credit and also Sticky Prices.” mimeo.

Lucas, R. 1972. “Expectations and also the Neutrality that Money.” Journal of economic Theory 4, 103-24.

Mankiw, N. 1985. “Small Menu costs and big Business Cycles: A Macroeconomic Model.” Quarterly newspaper of Economics 100, 529-38.

Mortensen, D., and C. Pissarides. 1999. “New advances in Models of search in the job Market.” Handbook of job Economics, O. Ashenfelter and D. Card, eds.

Rotemberg, J. 1982. “Sticky prices in the unified States.” Journal of political Economy 90, 1187-1211.

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Taylor, J. 1980. “Aggregate Dynamics and Staggered Contracts.” Journal of political Economy 88, 1-23.