Nominal Rigidities Research Articles

Approximating Nash equilibrium for production control with sticky price

We study a mean field game problem arising from the production control for multiple firms with price stickiness in the commodity market. The price dynamics for each firm is described as a (controlled) jump-diffusion process with mean-field interaction. Each firm aims to maximize her expectation of cumulative net profit coupled with each other through price processes. By solving the limiting control problem and a fixed-point problem, we construct an explicit approximating Nash equilibrium when the number of firms grows large.

The role of dispersed information in inflation and inflation expectations

We solve a rational expectations model of price formation with nominal rigidity and information frictions analytically to study how dispersed information impacts inflation and inflation expectations, without imposing strong structural assumptions on the aggregate marginal cost. We derive a Phillips curve that links inflation, average inflation forecast (i.e., a first-order expectation), and the net effect of higher-order expectations (HOEs). We quantify the essential role of dispersed information in generating inflation inertia and predictable average nowcast and forecast errors. The estimated effect from dispersed information explains a significant inflation variation, and the net effect of HOEs provides a novel micro-foundation for markup shocks.

Discussion on “Optimally Sticky Prices: Foundations (by Jean-Paul L’Hullier and William R. Zame)”

Anufriev et al. study whether more detailed order book information is always better for market efficiency in a modified continuous double auction market. This paper belongs to a broad research agenda on the impact of information transparency and trading speed on market stability. This comment discusses the implication of this research agenda on the design of market institutions and regulatory policies with the rise of mobile trading platforms and algorithm trading.

Monetary policy and welfare in a currency union

AbstractI explore the welfare implications of currency union (CU) membership in a model that generates a trade-off between alternative monetary arrangements. While national currencies support country-specific monetary policies, a CU eliminates some barriers to trade and transitory cross-border price misalignments caused by nominal rigidities. I quantify the welfare gap between these two arrangements and show that it depends crucially on the correlation of shocks across the countries involved. I estimate the model with data from 11 Eurozone members and I seek the minimum trade gains needed to make a single currency worthwhile for them. I find that modest trade gains are likely to be sufficient, given the good business-cycle affiliation of these economies.

High price premiums as barriers to organic meat demand? A hedonic analysis considering species, cut and retail outlet*

Rigid price setting and high organic price premiums have been perceived as major purchase barriers to organic meat products. While emerging price and product differentiation have been reported for organic products in other categories, empirical evidence for the organic fresh meat market is lacking. We estimate a hedonic pricing model based on German household scanner data for fresh red meat and poultry purchases from 2012 to 2014. We derive and test for differences in organic price premiums across distribution channels, species and product type. Our results indicate significant variation in organic premiums, which range from 14 per cent for minced beef to 108 per cent for chicken breasts, and are considerably lower than previously reported estimates. We also find substantial overlaps in the distributions of conventional and organic prices for selected products. Our results suggest that high price premiums can no longer serve as the dominant explanation for low market shares of organic red meat. Marketers and policymakers may instead communicate the benefits of organic meat over conventional premium alternatives more clearly or increase the availability of organic meat.

China’s Currency Sterilization and Fiscal Centralization

During the late 1980s and early 1990s, the Chinese economy experienced painful tradeoffs between high economic growth and low inflation: stimulating GDP growth would cause severe inflation spikes, while controlling inflation rates would seriously contract GDP growth. In 1994, the Chinese government initiated a series of macroeconomic reforms to revitalize the Chinese economy. After that, the inflation dropped steadily and eventually achieved the “soft landing” in 1996. The high GDP growth rate has also been stabilized. This research elucidates two core components embedded in China’s 1994 program: currency sterilization and fiscal (revenue) centralization. The results suggest that classic economic models with nominal rigidity postulation may not be compatible with the Chinese economy.

Reevaluating the Role of Cost-Push and Technology Shocks in a Sticky Price Model

This paper sets up a nominal price rigidity model with catching up with the Joneses to address the relative importance of technology, cost-push, and monetary policy shocks in driving business cycles. This paper shows that the technology shock is the most important source of the post-war U.S. output and inflation variations, and the cost-push shock plays a moderate role in output variations in the model with habit. This finding contrasts with Ireland's results, wherein the cost-push shock explains 80% of output variations in the long run in the sticky price model without habit in consumption.

Revisiting the optimal inflation rate with downward nominal wage rigidity: The role of heterogeneity

In this paper, I study the optimal inflation rate in a sticky price economy where workers are heterogeneous in labor productivity and wage changes are subject to asymmetric adjustment costs. The model calibrated to U.S. micro wage data implies downward nominal wage rigidity (DNWR). The optimal inflation rate is substantially higher than stated in the literature in the presence of worker heterogeneity. A key to understanding the result is that DNWR causes a cross-sectional misallocation of labor as well as inefficient aggregate dynamics, enlarging the “grease the wheels” effect of inflation.

Uncertainty Shocks, Innovation, and Productivity

Abstract In this paper, we argue that macroeconomic uncertainty shocks cause a persistent decline in economic activity, investment in R&D, and total factor productivity. After providing empirical evidence, we build a DSGE model with sticky prices and endogenous growth through investment in R&D. In this framework, uncertainty shocks lead to a short-term fall in demand because of precautionary savings and rising markups. The reduction in the utilised aggregate stock of R&D determines a fall in productivity, which causes a long-term reduction in the main macroeconomic aggregates. When households feature Epstein–Zin preferences, they become averse to these long-term risks affecting their consumption process (long-run risk channel), which severely exacerbates the precautionary savings motive and the overall adverse effects of uncertainty shocks.

Price, sales, and the business cycle: Microeconomic evidence

This paper uses a rich weekly price database from the largest supermarket in Uruguay to analyze the relationship among prices, micro-level sales, and business cycle conditions. On average, 7% of products were on sale each month, and we show a positive and statistically significant but small relationship between sales and unemployment at the aggregate level, controlling for product and time effects. For each product category, there is a high and positive statistically significant association for these variables. Also, for some categories like food products, alcoholic drinks, beverages, and fruits and vegetables, we found a large, negative, and statistically significant relationship between the probability of being on sale and employment. The mechanism we tested is the following: As the economy worsens and unemployment rises (and/or employment falls), the supermarket uses sales to adjust prices while keeping reference prices fixed. Our results indicate that sales do not alleviate much of the price rigidity in economic recessions. We also studied sales behavior through a principal component analysis in the time domain. This analysis revealed that the first two principal components explained more than half of each sector’s variance in price dynamics. These components are significantly correlated with variations in unemployment and employment. Additionally, we found that movement in the principal components across sectors systematically Granger-cause employment changes.

Demand shocks and price stickiness in housing market dynamics

The current study establishes a dynamic stochastic general equilibrium model with sticky housing prices and compares the heterogeneous macro effects of exogenous uncertainty shocks on housing market dynamics in China. Based on Bayesian estimation, the findings indicate that 1) intertemporal/intratemporal preference and liquidity constraint shocks significantly affect housing market dynamics through different channels; 2) macro effects of demand shocks exhibit frequency-domain dependence, thereby suggesting the crucial role of stickiness; and 3) housing price stickiness significantly exacerbates fluctuation and postpones the convergence of housing markets under demand shocks, particularly in the post-crisis period; additionally, it asserts an asymmetric effect in booming and cooling markets. Furthermore, the counterfactual analysis provides policy suggestions to correct the housing market dynamics associated with demand shocks and price stickiness.

Inefficient relative price fluctuations

We measure the extent of inefficient fluctuations in the relative price of investment in the US using an estimated two-sector New Keynesian model. In the presence of these fluctuations, inefficiencies in the economy are summarized by the variation in the following policy objects: the relative price gap, sectoral output gaps, and sectoral price and wage inflation. The welfare-maximizing monetary authority cannot reduce the volatility of the relative price gaps due to nominal rigidity in both sectors. However, it can manage trade-offs among the other policy objects, both across and within sectors. Identifying the nature of shocks that drive the relative price of investment is important for central banks in deciding the optimal weights on sectoral price inflation under the composite inflation targeting rule. This is because the property of trade-offs depends on whether shocks alter the efficient relative price or not.

Do Sticky Wages Matter? New Evidence from Matched Firm Survey and Register Data

We study the causal effects of downward nominal wage rigidity after a deflationary monetary policy shock using Swiss data on employee‐level contractual wages matched with income and employment from social security register data. We exploit the discontinuity around the origin of the wage growth distribution to compare the outcomes of individuals with wage freezes (treatment group) and small wage cuts (control group) before and after an unexpected decision by the Swiss National Bank leading to a 1% decline of the price level. Locally (that is, near the origin of the wage growth distribution), downward nominal wage rigidities cause a 4.4% decline in income and a 0.7 percentage point increase in the probability of unemployment. In the aggregate, income declines by 0.3% and the probability of unemployment increases by 0.05 percentage points.

Loss aversion in housing appraisal: Evidence from Italian homeowners

Loss aversion is considered a driver of downward price rigidity in real estate markets: during downturns – when market price of their house is below the price at which they purchased it – loss averse homeowners do not evaluate their houses at the former one but anchor the resale price to the latter price. As a consequence, prices are sluggish to adjust downward, time to sale becomes longer, ask and transaction prices differ.We document loss aversion for the Italian real estate market and complement the existing literature along two dimensions: (i) we test for loss aversion using homeowners’ evaluations of their houses, rather than ask or final prices, as customary in the literature; (ii) we document variation across household characteristics in the degree of loss aversion.We find that homeowners subject to estimated losses stick to the price at which they purchased and do not revise their assessment in response to downward market conditions, whereas the evaluation of those expecting a gain is independent of previous sale prices. Although there is a strong case for loss aversion in our sample, we document some variation across demographic groups: poorer, younger and less educated households show more reference dependence than the average one.

Is there news in inventories?

We identify total factor productivity (TFP) news shocks using standard VAR methodology and document a new stylized fact: in response to news about future increases in TFP, inventories rise and comove positively with other major macroeconomic aggregates. We show that the standard theoretical model used to capture the effects of news shocks cannot replicate this fact when extended to include inventories. We derive the conditions required to generate a procyclical inventory response by using a wedges approach. To explain the empirical inventory behavior, we consider two mechanisms: sticky wages and the presence of knowledge capital accumulated through learning-by-doing. Only the latter moves the wedges to qualitatively match the empirical behavior. The desire to take advantage of higher future TFP through knowledge capital drives output and hours choices on the arrival of news and leads to inventory accumulation alongside the other macroeconomic variables. The broad-based comovement a model with knowledge capital can generate, supports the view that news shocks are an important driver of aggregate fluctuations.

Capital and income inequality: An aggregate-demand complementarity

A novel complementarity between capital and income inequality leads to a significant amplification of the effects of aggregate-demand shocks on consumption. We characterize this finding using a simple model with heterogeneity in household saving and income, nominal rigidities, and capital. A fiscal policy that redistributes capital income causes further amplification, whereas redistributing profits generates dampening. After an interest rate shock, consumption inequality is more countercyclical than income inequality, consistent with the available empirical evidence. Procyclical investment also requires a more aggressive Taylor rule in order to attain determinacy, and aggravates the forward guidance puzzle.

The Macroeconomic Controversy Over Price Rigidity — How to Resolve it and How Bayesian Estimation has Led us Astray

Price rigidity plays a central role in macroeconomic models but remains controversial. Those espousing it look to Bayesian estimated models in support, while those assuming price flexibility largely impose it on their models. So controversy continues unresolved by testing on the data. In a Monte Carlo experiment we ask how different estimation methods could help to resolve this controversy. We find Bayesian estimation creates a large potential estimation bias compared with standard estimation techniques. Indirect estimation where the bias is found to be low appears to do best, and offers the best way forward for settling the price rigidity controversy.

How social learning affects customer behavior under the implementation of TOU in the electricity retailing market

As a representative motivative scheme in demand response implementation, time-of-use (TOU) pricing has significant potentials in achieving load-shifting goals. Meanwhile, social learning among customers, becoming popular with the development of information technologies, also profoundly affects customer consumption decisions. Still, its impacts on power customer consumption behaviors under implementing the TOU scheme remain unexplored. We propose an evolutionary game-theoretical model that incorporated social learning to illustrate how customer power consumption behaviors evolve if they learn from each other, where consuming relations between power consumers and retailers are formulated on account of the bipartite graphs. In every period, the retailers establish the TOU scheme based on the historical demand to optimize its current profits and load-shifting effects, and the customers, in turn, dispatch their consumptions for utility maximizations subjected to the proposed prices. We simulate the different scenarios of consumer behavior decisions verify our model by empirical data. Our results demonstrate how social learning changes consumer behavior and maximizes all consumers' utility. Noteworthy, Social learning brings volatility to the market, which incurs fluctuations for both firms' payoffs and customer utilities. Besides, we derive that the rigid price caps can guarantee customers positive utilities, and more communications among customers will lead to the decay of the entire retailing profits. This research provides decision support for consumer behavior and pricing of power retailing companies in the context of social learning.

The impact of commodity price volatility on fiscal balance and the role of real interest rate.

The objective of this study is to explore the impact of commodity price volatility on the governments’ fiscal balance. Using a dynamic panel data model for 108 countries from 1993 to 2018, this study finds that governments’ fiscal balance deteriorates with commodity price volatility, especially for commodity-exporting economies. A one standard deviation increase in commodity price volatility leads to a reduction of approximately 0.04 units in the fiscal balance as a percentage of gross domestic product. Further, we examine the role of real interest rates in influencing the relationship between commodity price volatility and fiscal balance. The empirical results suggest that the negative impact of commodity price volatility on fiscal balance can be mitigated with a lower real interest rate. This implies under the sticky price assumption, an accommodative monetary policy could be effective in moderating the negative effect of commodity price volatility on fiscal balance.

Lucas’ expectational equilibrium, price rigidity, and descriptive realism

ABSTRACT Robert Lucas' ([1972b] 1981a) article on the neutrality of money represented the first effective challenge to Samuelson’s neoclassical synthesis methodological separation between static microeconomic optimisation and macroeconomic dynamics. Lucas rejected disequilibrium price dynamics, as expressed by the Walrasian tâtonnement and auctioneer mechanisms. Lucas’ new treatment of equilibrium as an expectational concept, determined by the rational behaviour of information processing agents, was not restricted to market clearing competitive economies. Lucas’ effort to compare alternative rational expectations models of price stickiness (including his 1972 original formulation) led him to stress the notion of descriptive realism of the models’ main assumptions, which played an important role in his original discussion of model robustness.