Daley, Clayton (2007): A “Local” Model of the Firm: Sticky prices and the Phillips Curve.
Download (202Kb) | Preview
Assume a firm concerns itself exclusively with local shocks (copious citations including Lucas 1972 and Bomhoff 1983 validate that this type of assumption may be reasonable). Changes in a firm's production policy should occur when the actual demand in a period Dt suggests that the underlying demand function has shifted from expected demand E(Dt). Since firms face uncertainty, this is non-trivial and they must find a way to determining (given information from a single, current period) whether or not the underlying demand has changed or whether the firm has simply obtained a draw from its expected demand distribution.
In a simplified model, a firm can use a concept similar to a Statistical Hypothesis Test on E(Dt) = Dt to come to this conclusion. Rather than select an arbitrary confidence threshold (alpha), a firm can reverse the process and use the "marginal" alpha (where the hypothesis is just rejected or accepted) as its confidence that the mean has changed, allowing it to update its expectations to E(Dt+1) = (1-a) * E(Dt) + a * (Dt) and price accordingly. By weighting new demand information using this "confidence factor," the model introduces significant and persistent rigidity around NAIRU/equilibrium.
This model is also powerful because it explains the qualified success of threshold like behaivor in classical "menu cost" theories (as the threshold reflects the classic hypothesis test strategy), behavior similar to a learning model (via the weighted introduction of new data) and seeming information lags (via the low confidence in new information immediately after shifts), among others.
|Item Type:||MPRA Paper|
|Original Title:||A “Local” Model of the Firm: Sticky prices and the Phillips Curve|
|Subjects:||E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General|
|Depositing User:||Clayton Daley|
|Date Deposited:||12. Jul 2007|
|Last Modified:||13. Feb 2013 07:23|
Ball, Laurence and Romer, David, (1989) "The Equilibrium and Optimal Timing of Price Changes," Rev. Econ. Stud., 56(2), pp. 179-98. Barro, Robert J. (1972) "A Theory of Monopolistic Price Adjustment," Rev. Econ. Stud., Jan. 1972, 39(1), pp: 17-26. Barro, Robert J. (1976) "Rational Expectations and the Role of Monetary Policy," . Monet. Econ., Jan. 1976, 2(1), pp.1-32. Blinder, Alan S. (1991) "Why Are Prices Sticky? Preliminary Results from an Interview Study," The American Economic Review (May 1991), pp. 89-96. Bomhoff, Edward J. (1983) Monetary Uncertainty. North Holland. Brunner, Karl, Alex Cukierman and Allan H. Meltzer (1983) "Money and Economic Activity: Inventories and Business Cycles," Journal of Monetary Economics (May 1983), pp. 281-319. Carlton, Dennis W. (1986) "The Rigidity of Prices," American Economic Review,Vol . 76, No. 4, (September 1986), pp. 637-658. Coibion, Olivier (2006) "Testing the Sticky Information Phillips Curve." Job market working paper. Gordon, Rober J. (1981) "Output Fluctuations and Gradual Price Adjustment," J. Econ. Lit, June 1981, 19(2), pp. 493-530 Gordon, Robert J. (1991) "What Is New-Keynesian Economics?," NBER Reprints 1513, National Bureau of Economic Research, Inc. Klenow, Peter J. and Willis, Jonathan L. (2006) "Sticky information and sticky prices," Research Working Paper RWP 06-13, Federal Reserve Bank of Kansas City. Mankiw, N. Gregory, and Reis, Ricardo (2002) Sticky information versus sticky prices: A proposal to replace the new Keynesian Phillips curve. Quarterly Journal of Economics 117, 1295-1328. Mankiw, Gregory N. and Ricardo Reis (2006) “Pervasive Stickiness,” American Economic Review, May 2006, 96 (2), 164–69. Meltzer, Allan H. (1982) "Rational Expectations, Risk, Uncertainty and Market Responses," in Paul Wachtel, ed., Crises in the Economic and Financial Structure. Lexington Books, 1982, pp. 3-22. Meltzer, Allan H. (1995) "Information, sticky prices and macroeconomic foundations," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 101-118. Muth, John F. (1961) "Rational Expectations and the Theory of Price Movements," Econometrica (July 1961), pp. 315-35. Sims, Christopher (2003) “Implications of Rational Inattention,” Journal of Monetary Economics, April 2003, 50 (3), 665-90. Woodford, Michael. (2003) “Imperfect Common Knowledge and the Effects of Monetary Policy” in Knowledge, Information, and Expectations in Modern Macroeconomics: In Honor of Edmund Phelps, ed. by P. Aghion, R. Frydman, J. Stiglitz, and M. Woodford, Princeton University Press.