Incomplete Price Adjustment and Inflation Persistence

Marcelle, Chauvet and Insu, Kim (2019): Incomplete Price Adjustment and Inflation Persistence.

Abstract

This paper proposes a sticky inflation model in which inflation persistence is endogenously generated from the optimizing behavior of forward-looking firms. Although firms change prices periodically, their ability to fully adjust them in response to changes in economic conditions is assumed to be constrained due to the presence of managerial and customer costs of price adjustment. In essence, the model assumes that price stickiness arises from a combination of staggered contracts as in Calvo (1983) as well as quadratic adjustment cost as in Rotemberg (1982). We estimate the model using Bayesian techniques. Our findings strongly support both sources of price stickiness in the U.S. data. The model performs well in matching microeconomic evidence on price setting, particularly regarding the size and frequency of price changes. The paper also shows how incomplete price adjustments in a staggered price contracts model limit the contribution of expectations to inflation dynamics: it generates the delayed response of inflation to demand and monetary shocks, and the observed correlation between inflation and economic activity.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation Persistence, Phillips Curve, Sticky Prices, Convex Costs, Incomplete Price Adjustment, Infrequent Price Adjustment
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C68 - Computable General Equilibrium Models; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

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