Nominal Rigidities Research Articles

Earnings-Based Borrowing Constraints and Macroeconomic Fluctuations

Microeconomic evidence reveals a direct link between firms' current earnings and their access to debt. This paper studies macroeconomic implications of earnings-based borrowing constraints. In a macro model, firms with earnings-based constraints borrow more in response to positive investment shocks, whereas firms with collateral constraints borrow less. Empirically, aggregate and firm-level credit responds to identified investment shocks according to the predictions with earnings-based constraints. Moreover, with sticky prices, earnings-based constraints imply that supply shocks are quantitatively more important. This is validated in an estimated version of the model, highlighting the importance of carefully modeling credit constraints to understand policy trade-offs. (JEL E22, E32, G31, G32)

Downward nominal house price rigidity: Evidence from three centuries of data on housing transactions

By analyzing housing data from the period 1850 to 2019 in Norway, we find evidence of downward nominal house price rigidity. More specifically, we document that there is a marked fraction of repeat-sales housing transactions with a zero nominal price change and show that this fraction increases in housing market downturns. While the former result reveals a rigidity in nominal house prices, the latter suggests that the direction of it is predominantly downward.

Currency misalignments, international trade in intermediate inputs, and inflation targeting

In the literature on optimal monetary policy in open economies, the presence of local- currency pricing provides a rationale for targeting CPI inflation rather than PPI inflation. In this paper, we reexamine this conclusion by incorporating international trade in intermediate inputs into Engel (2011). We find that the cooperative monetary policymaker should target the final-goods output gaps, the PPI inflation rates at both stages of production, the currency misalignments at both stages of production, and the vertical relative price gaps. Welfare analysis shows that the monetary policymaker should target the weighted average intermediate-goods PPI (WPPI) inflation rather than CPI inflation for most combinations of price stickiness at both stages of production.

The inflationary effects of sectoral reallocation

The COVID-19 pandemic has led to an unprecedented shift of consumption from services to goods. We study this demand reallocation in a multi-sector model featuring sticky prices, input-output linkages, and labor reallocation costs. Reallocation costs hamper the increase in the supply of goods, causing inflationary pressures. These pressures are amplified by the fact that goods prices are more flexible than services prices. We estimate the model allowing for demand reallocation, sectoral productivity, and aggregate labor supply shocks. The demand reallocation shock explains a large portion of the rise in U.S. inflation in the aftermath of the pandemic.

Price rigidity, wholesale price passthrough, and quality‐tiered private labels

AbstractQuality‐tiered private labels have become a main strategy for grocery retailers. However, impacts of private label development on wholesale prices and their effects on retail price rigidity remain unanswered as appropriate wholesale price data remain scarce. This paper fills this research gap by analyzing retail‐pricing behavior and wholesale passthrough for categories with quality‐tier differentiated private labels. We find the speed of wholesale passthrough to differ across categories, quality tier, and direction of adjustment. Overall, we find wholesale prices to play a secondary role to price promotions in explaining price rigidity across grocery categories with quality‐tiered private labels.

Having a Profit Center of Fuel and Mineral Trading is Already Essential for the Mining Companies and the Skillsets they Need

Price uncertainties are increasing as diverse buyers and sellers are coming into the fuel and minerals market. There are supplyside uncertainties due to resource depletion, supply chain problems, and prolonged wars and conflicts. Uncertainties enhance risk. Moreover, standard trading practices in the minerals and oil and gas industries like long-term supply agreements with rigid price–fixing mechanisms are being challenged by short-term trading agreements and contracts where the price rigidities are non-existent; the market determines the price on the basis of the supply of buyers and sellers in an open market. Moreover, the market for derivatives of minerals and oil and gas is becoming more pronounced as the various uncertainties to secure materials supply are growing. In order to tread in the unknown waters of flexible trading, the mining companies can think of opening a profit center with qualified people to tide over the challenges and to gather knowledge of the trading system, which will also influence how the financing of the project investments would take place in the future.

The paradox of price flexibility in an open economy

Empirical evidence suggests that the degree of price stickiness is not uniform around the world. Heterogeneous price stickiness introduces a new propagation mechanism of global demand shocks that lead to a liquidity trap for all countries, which we call the open-economy paradox of flexibility. We show that the severity of the paradox increases with the degree of trade and capital market openness, when home and foreign goods are Edgeworth substitutes and when the more affected home country runs a trade deficit. This implies that highly open trade and financial linkages are not desirable in terms of world welfare. We show that the inefficiencies generated by heterogeneous price stickiness can be reduced through two types of international policy coordination: i) an arrangement in which the country with relatively sticky prices raises the interest rates or ii) a monetary union.

The effects of uncertainty shocks: Implications of wealth inequality

This paper investigates whether and how the effects of time-varying macroeconomic uncertainty depend on the distribution of wealth. I show that increases in wealth inequality amplify the responses to uncertainty shocks. Using deciles of the distribution of wealth along with a series of macroeconomic volatility for the United States, I find that consumption growth falls by approximately 0.25 percentage points more in response to a one standard deviation uncertainty shock when wealth inequality is high relative to when it is low. In order to understand the nonlinear effects of uncertainty on consumption growth, I consider a two-agent New Keynesian model. I calibrate this simple model to qualitatively match the empirical responses of consumption growth to a one standard deviation uncertainty shock and show that nominal rigidities are key to magnifying the effects of uncertainty under high wealth inequality.

The Demand for Trade Protection over the Business Cycle

AbstractWe build measures of the demand for trade protection, and relate them to permanent productivity and transitory monetary shocks identified from U.S. data. The demand for trade protection is countercyclical conditional on productivity shocks and procyclical conditional on monetary shocks. A two‐country dynamic stochastic general equilibrium (DSGE) model with trade in intermediate and final goods, sticky prices, and incomplete financial markets is proposed, in which tariffs are determined in a repeated noncooperative policy game. The resulting trade policies are consistent with the empirical evidence about the cyclical pattern of trade protection demand.

Equity Home Bias in a Capital Market Union

I study the social efficiency and aggregate effects of equity home bias using a general equilibrium model with nominal rigidities and a fixed exchange rate. I find that the source of home bias is key for analyzing the wedge between equilibrium and socially optimal levels of home bias. Surprisingly, when home bias is due to labor income hedging effects, stock positions tend to be approximately efficient despite the aggregate demand externalities induced by the rigidities. On the other hand, home stock positions are excessive when home bias is due to financial frictions or biased expectations. The key theoretical results hold numerically well in a more general quantitative model.

Money demand by firms, labor market frictions, and optimal long-run inflation

Abstract Optimal monetary policy, under flexible and sticky prices, and sticky nominal wages are studied in the canonical matching model of the labor market with a working capital channel. A money demand by firms is motivated by the fact that a significant amount of M1 is held by firms. As a result of the working capital, the Ramsey-optimal monetary policy calls for inflation when employment is above the socially efficient level and for deflation when it is below that level. This result holds under flexible wages as well as nominal wage rigidities. In other words, to improve labor market efficiency, deflation is necessary to “grease the wheels of the labor market.” Although there is no relationship between optimal monetary policy and the market tightness under flexible prices, a long-run and mainly negative relationship between the optimal inflation rate and the equilibrium tightness emerges under sticky prices.

The Specific Behavior of Economic Agents with Heterogeneous Expectations in the New Keynesian Model with Rigid Prices and Wages

The purpose and scientific novelty of this work is to analyze the changes and features of economic agents’ behavior when incorporating wage rigidity into a new Keynesian model under cognitive constraints of agents. The working hypothesis is the assumption that the forecasting of the output gap, inflation of prices and wages occurs with the help of fundamentalist and extrapolation rules. The first rule is based on forecasting the variables under study on the basis of their stationary values. The second rule is based on extrapolation of the latest available data on inflation and the output gap. The weight shares of agents applying these heuristic rules change endogenously, which is the source of endogenous waves of optimism and pessimism. An analysis of the impulse responses of interest rate and technology shocks suggests that a more flexible economy (an economy with flexible wages and rigid prices) is less prone to a spike in the economic cycle caused by waves of optimism and pessimism than a more rigid economy (an economy with rigid prices and wages) due to the inability of agents to respond immediately to exogenous disturbances in rigid conditions. Thus, these shocks cause wave effects in the economy, i.e., cyclical movements, i.e., a rigid economy will be more prone to booms and busts caused by alternating optimism and pessimism than a flexible economy. The model with an imperfect labor market is characterized by an increased concentration of vital forces at the values of 0 and 1, as well as in the mid-distribution compared to the base model. This feature provides a key explanation for the abnormal dynamics of the evolution of variables in this model. It is concluded that the difference between the degree of optimism and pessimism in the base model and in the model with rigid wages and prices is the full trust of agents in the central bank in targeting wage inflation in the absence of the stabilization of this inflation by the bank.

Exchange rate uncertainty and the connectedness of inflation

In this study, we examine the connectedness of exchange rate uncertainty and inflation. In an economy with a flexible exchange rate, price rigidities can lead importers to carry exchange rate risk and they impose a premium for the risk they face by increasing consumer prices. This pricing behavior provides a channel between exchange rate uncertainty and overall price level. We empirically analyze the impact of exchange rate uncertainty on inflation by using panel data from 149 countries over the period 1980–2017. The estimation results point that the uncertainty of the exchange rate has a significant and positive effect on inflation. We also show that effect of exchange rate uncertainty on inflation is nonlinear. As the exchange rate uncertainty increases, the size of its effect on inflation decreases. Moreover, the degree of exchange rate pass-through and the effect of exchange rate uncertainty on inflation differ among country groups and their effects on inflation have decreased through time.

International heterogeneity of nominal wages and optimal monetary policy

AbstractThis paper examines optimal monetary policy in a two‐country model with staggered nominal prices and wages. We show that given home nominal wage stickiness, changes in the degree of foreign nominal wage stickiness substantially impact the worldwide welfare losses and gains from commitment policy. Specifically, the welfare gains from a commitment policy are greatest when nominal wages in both countries are perfectly flexible. However, when nominal wages in the foreign country are stickier, the gains from commitment decrease.

The Inflationary Effects of Sectoral Reallocation

The COVID-19 pandemic has led to an unprecedented shift of consumption from services to goods. We study this demand reallocation in a multi-sector model featuring sticky prices, input-output linkages, and labor reallocation costs. Reallocation costs hamper the increase in the supply of goods, causing inflationary pressures. These pressures are amplified by the fact that goods prices are more flexible than services prices. We estimate the model allowing for demand reallocation, sectoral productivity, and aggregate labor supply shocks. The demand reallocation shock explains a large portion of the rise in U.S. inflation in the aftermath of the pandemic.

Optimal Fiscal Consolidation Under Frictional Financial Markets

Abstract This paper studies optimal fiscal policy in a currency union subject to capital flow shocks in an economy with two main ingredients: (i) sticky prices and (ii) financially constrained arbitrageurs. Given capital outflows and high external debt, the fiscal authority faces a trade-off between stimulating the economy or paying off external debt. The planner reduces the value-added tax in the short run, while it raises and front-loads the sum of value-added tax and payroll taxes. It is not optimal to use spending to stimulate the economy. The country engages in a fiscal consolidation, as government debt falls compared with a passive fiscal policy.

Duopolistic competition and monetary policy

To consider the strategic pricing of duopolistic firms and its implications for monetary policy, this study constructs a tractable duopoly model with price stickiness. Dynamic strategic complementarity, in which an increase in a firm’s price increases the optimal price set by the rival firm in the following periods, increases steady-state price and the real effect of monetary policy. However, when temporary sales arise as a mixed strategy, the real effect of monetary policy decreases considerably.

Drought shocks and price adjustments in local food markets in Chile: Do product quality and marketing channel matter?

AbstractLately, economies have been facing an increase in the frequency and magnitude of droughts, which come with potential consequences on food prices. This article aims to analyze how drought disturbances affect price differences in local food markets. Special attention is paid to differences in product quality and marketing channels. To study the mechanism behind price differences, our analysis is framed within the food market integration theory. Our methodology follows a dyadic regression approach, which allows us to exploit the panel data structure of our market price data. We use monthly Asterix potato and long shelf‐life tomato market prices from traditional markets and supermarkets in Chile. To measure drought intensity, we use remote sensing data to construct a drought index. Results show that drought shocks reduce market price differentials around harvesting and commercialization periods, which is supported by the existence of market integration. We also find that prices of high‐quality products, less perishable products, and those taken from traditional markets respond more intensively to droughts and take more time to be transmitted. A direct link between droughts and crop quality, as well as supermarkets’ larger capacity for buffer stock, may be behind these interpretations. Product differentiation and retail price rigidity arguments are also discussed.

Fiscal multipliers: A heterogenous‐agent perspective

We use an analytically tractable heterogeneous‐agent (HANK) version of the standard New Keynesian model to show how the size of fiscal multipliers depends on (i) the distribution of factor incomes, and (ii) the source of nominal rigidities. With sticky prices but flexible wages, the standard representative‐agent (RANK) model predicts large multipliers because profits fall after a fiscal stimulus and the resulting negative income effect makes the representative worker work harder. Our HANK model, where workers do not own stock, and thus do not receive profit income, predicts smaller fiscal multipliers. In fact, they are smaller with sticky prices than with flexible prices. When wages are the source of nominal rigidity, in contrast, fiscal multipliers are close to one, independently of income heterogeneity and price stickiness.

The Government Spending Multiplier in a Multisector Economy

We study the effects of aggregate government spending shocks in a production network economy where sectors differ in their price rigidity, factor intensities, use of intermediate inputs, and contribution to final demand. The model implies an aggregate value-added multiplier that is 75 percent (and $0.32) larger than that obtained in the average one-sector economy. This amplification is mainly driven by input–output linkages and—to a lesser extent—sectoral heterogeneity in price rigidity. Aggregate government spending shocks also lead to heterogeneous responses of sectoral value added, which are larger among upstream industries. We present novel empirical evidence supporting this prediction. (JEL E12, E16, E23, E43, E52, E62, H50)