Menu Costs Research Articles

Does Information about Current Inflation Affect Expectations and Decisions? Another Look at Italian Firms

I document the response of the inflation expectations, and pricing and labour demand decisions of Italian firms to randomly provided information about recent inflation and assess the causal effect of the former on firms’ decisions. I use a standard menu cost model to show that conventional IV2SLS estimates based on variation of agents’ inflation expectations generated by experimental manipulation of their information sets are likely devoid of casual content because in such experimental settings some assumptions required for their causal interpretation fail. I discuss alternative estimators based on assumptions more likely to be consistent with the underlying theoretical framework. Empirically, I find that randomly informed firms substantially revise their inflation expectations but do not revise pricing and hiring decisions. Causal inference from appropriate estimators consistently reveals that the lack of reduced form effects reflects absence of statistically significant effects of expected inflation on firms’ decisions rather than offsetting responses. These results cast doubts on the possibility of obtaining substantial real effects through communication strategies that reach the general public more effectively.

The Pricing Strategies of Online Grocery Retailers

Matched product data is collected from the leading online grocers in the U.S. The same exact products are identified in scanner data. The paper documents pricing strategies within and across online (and offline) retailers. First, online retailers exhibit substantially less uniform pricing than offline retailers. Second, online price differentiation across competing chains in narrow geographies is higher than offline retailers. Third, variation in offline elasticities, shipping distance, pricing frequency, and local demo- graphics are utilized to explain price differentiation. Surprisingly, pricing technology (across time) magnifies price differentiation (across locations). This evidence motivates a high-frequency study to unpack the patterns of algorithmic pricing. The data shows that algorithms: personalize prices at the delivery zipcode level, update prices very frequently and in tiny magnitudes, reduce price synchronization, exhibit lower menu costs, constantly explore the price grid, and often match competitors’ prices.

Digitalization, retail trade and monetary policy

We study the role of digital transformation in the retail trade sector for the effectiveness of monetary policy. With the emergence of online retail trade, dynamic pricing concepts were introduced which reduced menu costs and rendered price changes more frequent. Our two-sector New Keynesian model implies that the real effects of monetary policy abate as the share of online retail trade rises. These theoretical results are empirically confirmed by means of an interactive Bayesian VAR model using data for the Euro area. Our findings identify a structural rather than a cyclical phenomenon for diminished monetary policy effectiveness.

The Skewness of the Price Change Distribution: A New Touchstone for Sticky Price Models

AbstractWe present a new way of empirically evaluating various sticky price models that are used to assess the degree of monetary nonneutrality. While menu cost models uniformly predict that price change skewness and dispersion fall with inflation, in the Calvo model, both rise. However, the U.S. Consumer Price Index (CPI) data from the late 1970s onward show that skewness does not fall with inflation, while dispersion does. We present a random menu cost model that, with a menu cost distribution that has a strong Calvo flavor, can match the empirical patterns. The model exhibits much more monetary nonneutrality than existing menu cost models.

Customer Search, Competition, and Monetary Non–Neutrality

In this paper, I study monetary non-neutrality in a frictional product market. The model incorporates the idea that goods are in general not monopolistically supplied; rather, consumers can purchase the same good from many outlets. I find that incorporating this feature into a menu cost model increases the degree of monetary non-neutrality. The reason is that competition between stores makes their prices complementary, so that firms face strong penalties for setting prices far away from their competitors. It makes pass-through of cost shocks heterogeneous and decreases the strength of the selection effect. I also use the model to study cyclical changes in monetary non-neutrality. I find that the data are consistent with a decline in the competitiveness of markets in recessions, which makes monetary policy less effective at stimulating output.

Inflation and income inequality in a variety-expansion growth model with menu costs

This study explores the effect of inflation on income inequality in a growth model with variety expansion and menu costs. Inflation is found to determine income inequality via both asset-value and interest-rates effects. Our numerical analyses show that higher inflation turns these effects negative, stifling economic growth and mitigating income inequality.

Effects of a mandatory local currency pricing law on the exchange rate pass-through

This paper discusses whether Law 28300 of 2004, that required Peruvian firms to express their prices in Peru’s currency in a context of high price dollarization, affected the exchange rate pass-through (ERPT). We hypothesize that the enactment of the Law introduced menu costs for firms that used to set their prices in dollars, prompting several of them to make a permanent switch to pricing in local currency. Using disaggregated consumer price index (CPI) data, we find that, following passage of the Law, the ERPT was completely offset for non-durable goods with dollarized prices, and partially offset for durable goods with dollarized prices. These effects may vary due to differences in imported component shares, market power, and markup pricing.

PRICE FLEXIBILITY AND OUTPUT VOLATILITY UNDER MENU COSTS

This paper studies the implications of price flexibility on output volatility under menu costs and finds price flexibility to be output-destabilizing under supply shocks, but not necessarily so under demand shocks. We illustrate that such a result hinges on the extent to which firms can adjust along both the intensive and the extensive margins, the latter of which is often absent in the literature.

Reallocation Effects of Monetary Policy

Responding to the increased attention on the distributional aspects of monetary policy, we investigate the reallocation among heterogeneous firms triggered by nominal growth. Japanese firm-level data show that large firms invest more in R&D and grow faster than small firms under higher inflation. We then construct a model that introduces nominal rigidity into R&D-driven endogenous growth with heterogeneous firms. The model shows that high nominal growth leads to an increase in the market share of innovative firms because menu-cost burdens are relatively heavier for less innovative firms. This reallocation effect yields a positive effect of monetary expansion on both real growth and welfare. The optimal nominal growth can be strictly positive even under nominal rigidity. Moreover, the presence of menu costs can improve welfare.

Temporary Price Changes, Inflation Regimes, and the Propagation of Monetary Shocks

We present a sticky price model that features the coexistence of many price changes, most of which are temporary, with a modest flexibility of the aggregate price level. Stickiness is introduced in the form of a price plan, namely a set of two prices: either price can be charged at any moment but changing the plan entails a menu cost. We analytically solve for the optimal plan and for the aggregate output response to a monetary shock. We present evidence consistent with the model implications using scanner data, as well as Consumer Price Index data across a wide range of inflation rates. (JEL D22, E31, E52, L11, O11, O23)

The Macroeconomics of Sticky Prices with Generalized Hazard Functions

We give a thorough analytic characterization of a large class of sticky-price models where the firm’s price setting behavior is described by a generalized hazard function. Such a function provides a tractable description of the firm’s price setting behavior and allows for a vast variety of empirical hazards to be fitted. This setup is microfounded by random menu costs as in Caballero and Engel (1993) or, alternatively, by information frictions as in Woodford (2009). We establish two main results. First, we show how to identify all the primitives of the model, including the distribution of the fundamental adjustment costs and the implied generalized hazard function, using the distribution of price changes or the distribution of spell durations. Second, we derive a sufficient statistic for the aggregate effect of a monetary shock: given an arbitrary generalized hazard function, the cumulative impulse response to a once-and-for-all monetary shock is given by the ratio of the kurtosis of the steady-state distribution of price changes over the frequency of price adjustment times six. We prove that Calvo’s model yields the upper bound and Golosov and Lucas’ model the lower bound on this measure within the class of random menu cost models. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Sales and Promotions and the Great Recession Deflation

This paper investigates the effect of sales and promotions on the pricing decisions of firms by providing a novel theoretical model where firms face menu costs when adjusting their price and offer items on sale to attract bargain hunters. It is demonstrated that in a recession, the frequency of items on sale increases as well as the effort of consumers to locate such offers. Since the decrease in the cost of living following a recession comes both from price decreases and the combination of more frequent sales and more active bargain hunting by consumers, a price index that simply focuses on prices and neglects high frequency sales and their weight in the consumer's basket appears to be less responsive to shocks. This can explain the low response of inflation in the post-crisis period and thus the breakdown of the Phillips curve as sales items are under-represented in common price indexes. This study also show that a price index created by placing more weight on sale items in the UK CPI correlates better with the output gap, confirming the model's predictions. Additionally, if agents form inflation expectations using indices that neglect sales and promotions, recessions are exacerbated.

Identifying Price Reviews by Firms: An Econometric Approach

AbstractPrice reviews are a potentially costly activity. A significant fraction of unchanged prices may stem from firms not reviewing prices, rather than from obstacles to changing prices per se, such as menu costs. In this paper, we disentangle these two causes of price stickiness by estimating an inflated ordered probit model on a panel of French manufacturing firms. The results point to a low frequency of price reviews, suggestive of the relevance of information costs as a determinant of the observed price stickiness. In view of the “inattentive producers” literature, pointing that the source of price rigidity matters, this is suggestive of a large real effect of monetary policy.

Regular Price Stickiness in German Food Retailing

Abstract The present study investigates the underlying factors of price stickiness in German food retailing using fluid milk as a case study. We distinguish the duration between two actual price changes and two regular price changes as measures for price stickiness. Especially in the case of private labels, the choice of proxy for price rigidity has important implications. If we consider (regular) price changes, private label products are more (less) rigid than national brands. Price rigidity increases in the product’s average price. Prices of low priced private labels are rather flexible. Price adjustment of high priced private labels is similarly sluggish compared to national brands. We rationalize this finding with variable mark-ups under imperfect competition. In line with previous research, we find that price stickiness also depends on product attributes, retail formats, menu costs, psychological price points, and time-varying market conditions.

On What States Do Prices Depend? Answers From Ecuador

AbstractThe frequency of retail price adjustment differs across goods, both in low inflationary environments, such has the United States, and in high inflationary environments typical of less developed countries. We develop a multishock menu cost model in which retailers intermediate trade between producers and consumers. Since the cost share of intermediate inputs varies across goods, the model produces a cross‐sectional distribution of frequency of price adjustment even though firms face a common menu cost. The model is evaluated using a rich micropanel of retail prices in Ecuador in a period spanning a financial crisis and subsequent dollarization.

Inflation and income inequality in a Schumpeterian economy with menu costs

This study incorporates heterogeneous households into a monetary Schumpeterian growth model via menu costs to explore the effect of inflation on income inequality. The source of income inequality stems from the unequal distribution across households’ assets. Given that households face the same wage rate, inflation that leads to a monotonically decreasing effect on economic growth helps mitigate income inequality by weakening the contribution of asset income relative to wage income.

A theory of sticky rents: Search and bargaining with incomplete information

This paper offers the first theoretical explanation of housing rent stickiness and differential stickiness by housing structure type, key features of rental markets worldwide. Previous theoretical work on the subject is sparse and explains why some landlords charge below-market rents, not stickiness. Apart from its interest for understanding housing markets and overall inflation, rent stickiness is intriguing because it shows that stickiness can emerge in markets where the typical menu cost logic does not apply, and where market participants typically engage in repeated bargaining over contracts. Our model involves search and bargaining with incomplete information in a two-period game, and generates stickiness in a novel manner. The key decision is the landlord's choice of whether to renegotiate, or not. Crucially, landlords do not know tenant perceptions of unit quality. The key force generating stickiness is that offering the identical contract preempts tenant search, thus limiting tenants' outside options, and resolves uncertainty early. Risk aversion reinforces this mechanism and yields differential stickiness by landlord type. Renegotiation risk for large landlords disappears because the different outcomes—rent increase, rent decrease, and vacancy—“average out.” Landlords who manage only one unit loathe vacancy, and are highly motivated to avoid renegotiation.

Product Revenue and Price Setting: Evidence and Aggregate Implications

Using retail scanner data, we find that the probability of price adjustment increases with a product's revenue, and the average absolute size of price adjustment decreases with the product's revenue. Furthermore, the responsiveness of prices to monetary shocks increases with product revenue. These facts are consistent with menu cost models in which the menu cost increases less than one-to-one with revenue, and inconsistent with models in which the menu cost increases one-to-one with revenue. In a calibrated menu cost model, the real effect of monetary policy is smaller in economies in which the price response to monetary policy shocks increases with revenue than in economies where no such relationships exist. Together with cyclical shifts in the revenue distribution, the increase in price responsiveness with revenue introduces a counter-cyclical effect that strengthens the real effect of monetary policy during recessions.

Menu Costs and the Bullwhip Effect: Supply Chain Implications of Dynamic Pricing

We study the supply chain implications of dynamic pricing. Specifically, we estimate how reducing menu costs---the operational burden of adjusting prices---would affect supply chain volatility. Fitting a structural econometric model to data from a large Chinese supermarket chain, we estimate that removing menu costs would: (i) reduce the mean shipment coefficient of variation by 7.2 percentage points (pp), (ii) reduce the mean sales coefficient of variation by 4.pp, and (iii) reduce the mean bullwhip effect by 2.9 pp. These stabilizing changes are almost entirely attributable to an increase in the mean sales rate.

The Roles of Price Points and Menu Costs in Price Rigidity

The Roles of Price Points and Menu Costs in Price Rigidity