Calvo Pricing Research Articles

The Macroeconomic Effects of Nonzero Trend Inflation

We study the macroeconomic effects of nonzero trend inflation in a simple dynamic stochastic general equilibrium model under three common time‐dependent pricing schemes: Calvo, truncated‐Calvo, and Taylor. We show that, regardless of the pricing mechanism, trend inflation leads to a reduction in the stochastic means of output, consumption and employment, and an increase in the stochastic mean of inflation beyond its deterministic steady‐state level. The variability of most aggregates also increases. These effects are quantitatively much stronger with Calvo pricing.

The Frequency of Price Adjustment and New Keynesian Business Cycle Dynamics

The Calvo pricing model that lies at the heart of many New Keynesian business cycle models has been roundly criticized for being inconsistent both with time series data on inflation and with micro-data on the frequency of price changes. In this paper we show that a modified version of the Gali and Gertler (1999) model, which allows for price setters, and whose structure can be interpreted in terms of menu costs and information gathering/processing costs, largely resolves both criticisms. Moreover, the resulting Phillips curve shares the explanatory power of the partial-indexation model and dominates the full-indexation model and the Calvo model. Estimating a small-scale New Keynesian business cycle model, our results indicate that the share of firms that change prices each quarter is just over 60 percent, broadly in line with the Bils and Klenow (2004) study of Bureau of Labor Statistics price data. Reflecting the importance of information gathering/processing costs, we find that most firms that change prices are rule-of-thumb price setters. Finally, compared to specifications containing either the Calvo model or the full-indexation model, the data provide much greater support for the Gali-Gertler model.

The New Keynesian Phillips curve under trend inflation and strategic complementarity

This paper shows that for standard calibration of the [Calvo, G., 1983. Staggered prices in a utility-maximizing framework. Journal of Monetary Economics 12, 983–998] model of price stickiness and under strategic complementarity, the optimal price is only defined for trend inflation rates of under 5.5%. This threshold is much lower than previously recognized, and below the average inflation rate in several industrialized countries. Furthermore, over the range for which the optimal price is defined, the slope of the New Keynesian Phillips curve is decreasing in trend inflation. That contradicts the stylized fact that the Phillips curve is flatter in low-inflation environments. Allowing the Calvo price signal to vary with trend inflation can help avoid these implications.

State-Dependency and Firm-Level Optimization: A Contribution to Calvo Price Staggering

We implement a tractable state-dependent Calvo price-setting signal dependent on inflation and aggregate competitiveness. This allows us to derive a New Keynesian Phillips Curve (NKPC) expressed in terms of the actual levels of variables-rather than in-deviation from steady state form - and thus a specification which is not regime-dependent. A consequence of our approach is that ex-ante all firms face the same optimization problem. This state-dependent NKPC nests the conventional hybrid NKPC form as a special case. Finally, we demonstrate the usefulness of our approach by, first, analyzing the persistence and variability of inflation shocks under different inflation regimes and then comparing our state-dependent and time-dependent NKPCs on US data.

The Frequency of Price Adjustment Viewed Through the Lens of Aggregate Data

The Calvo pricing model that lies at the heart of many New Keynesian business cycle models has been roundly criticized for being inconsistent both with time series data on in‡ation and with micro-data on the frequency of price changes. In this paper I develop a new pricing model whose structure can be interpreted in terms of menu costs and information gathering/processing costs, that usefully recognizes both criticisms. The resulting Phillips curve encompasses the partial-indexation model, the full-indexation model, and the Calvo model, and can speak to micro-data in ways that these models cannot. Taking the Phillips curve to the data, I …nd that the share of …rms that change prices each quarter is about 60 percent and, perhaps re‡ecting the importance of information gathering/processing costs, that price indexation is important for in‡ation dynamics.

Calvo Pricing and Imperfect Common Knowledge: A Forward Looking Model of Rational Inflation Inertia

In this paper we derive a Phillips curve with a role for higher order expectations of marginal cost and future inflation. We introduce a small idiosyncratic component in firms' marginal costs and let the economywide average marginal cost be unobservable to the individual firm. The model can then replicate the backward looking component found in estimates of the 'Hybrid' New Keynesian Phillips Curve, even though the pricing decision of the firm is entirely forward looking. The Phillips curve derived here nests the standard New-Keynesian Phillips Curve as a special case. We take a structural approach to imperfect common knowledge that allow us to infer whether the assumed information imperfections necessary to replicate the data are quantitatively realistic or not. We also provide an algorithm for solving a class of models involving dynamic higher order expectations of endogenous variables.

Inflation Dynamics, Marginal Cost, and the Output Gap: Evidence from Three Countries

Recent studies have argued that the New Keynesian Phillips curve (Calvo pricing model) is empirically valid, provided that real marginal cost rather than detrended output is used as the variable driving inflation. One interpretation of this result is that real marginal cost is not closely related to the output gap, and so models for monetary policy need to include labormarket rigidities. An alternative interpretation is that marginal cost and the output gap are closely related, but that the latter needs to be measured in a manner consistent with dynamic general equilibrium models. To date, there has been little econometric investigation of this alternative interpretation. This paper provides estimates of the New Keynesian Phillips curve for the U.S., the U.K., and Australia using theory-consistent estimates of the output gap. Using this theory to measure the output gap leads to a considerable improvement in the empirical performance of output-gapbased Phillips curves.

Pitfalls in the Modeling of Forward-Looking Price Setting and Investment Decisions

The present paper makes progress in explaining the role of capital for inflation and output dynamics. We followWoodford (2003, Ch. 5) in assuming Calvo pricing combined with a convex capital adjustment cost at the firm level. Our main result is that capital accumulation affects inflation dynamics primarily through its impact on the marginal cost. This mechanism is much simpler than the one implied by the analysis in Woodford's text. The reason is that his analysis suffers from a conceptual mistake, as we show. The latter obscures the economic mechanism through which capital affects inflation and output dynamics in the Calvo model, as discussed in Woodford (2004).