Coarse Pricing Policies

Abstract

How firms set prices has implications for the relative importance of different sources of fluctuations and for the effectiveness and design of monetary policy. This paper presents empirical evidence that firms choose pricing policies, rather than individual prices. These policies are coarse and sticky: they consist of a small number of prices and they are updated infrequently. A theory of information-constrained price setting generates such policies endogenously, and matches the discreteness, duration and volatility of policies in the data. Both the discreteness and the stickiness of the optimal policy reflect the firm's desire to economize on the costs of monitoring continuously changing market conditions. Policies track the state noisily, resulting in sluggish adjustment to nominal shocks. A higher volatility of shocks does not reduce monetary non-neutrality and generates slight inflation. Increased competition and progress in the technology to acquire information both result in deflation.