Even if price are slow-moving to adjust, this doesn’t necessarily average that monetary policy have the right to be supplied to wake up or slow financial activity



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Executive an overview

countless economists think that prices are “sticky”—they readjust slowly. This stickiness, castle suggest, means that changesin the money supply have an affect on the actual economy, inducing changes in investment, employment, output and also consumption, an impact that can be exploited through policymakers.

In this essay, we argue the price stickiness doesn’t necessarily create an exploitable policy option. We define a version in which money is neutral (that is, expansion or reduction in moneysupply doesn’t affect real financial activity) even in a paper definition of slow price adjustment.


here are two venerable concerns in macroeconomic theory and also policy analysis: room prices sticky? Does the matter?

by “sticky” prices, we average the observation that part sellers set prices in nominal state that perform not adjust quickly in an answer to changes in the accumulation price level or to alters in economic conditions more generally. Part macroeconomics together taught in the classroom and also used in exercise makes the presumption that in the name of prices space sticky and then proceeds come derive plan implications. In this essay, we want to challenge the idea that these policy ramifications are necessarily exactly (even if prices are sticky).

timeless macroeconomics embodied the idea the money is neutral—that is, increasing or to decrease the quantity of money in an economy has no impact on genuine economic task such together investment, production, usage or hiring. If money is neutral, that is not clear what monetary policy deserve to do.1

Some economists dispute timeless neutrality. Castle argue that nominal prices are sticky, at least in the brief run, and that this has significant consequences for the actual economy.2 The exact after-effects depend top top details, however many models that this institution of thought have actually this effect: If buyers have much more money and sellers keep their price the same, the previous will demand more goods and also services and the last (by assumption) will supply them. This generates rise in investment, employment, output and consumption.

The counterargument is that putting much more cash in people’s hands is like including a zero come every bill; that is, a one-dollar invoice becomes a 10-dollar bill, a 10 becomes a 100 and so on. Some economic experts say the this ought not have a actual impact, any an ext than changing the means temperature is measured indigenous Fahrenheit to Celsius would—it’s just units!

numerous economists allude out, however, that difficult prices room what we observe empirically and, indeed, there is an element of truth in their argument (see Klenow and also Malin 2010 because that a survey of empirical work). Then we might ask, why do some sellers collection prices in nominal state that perform not change in solution to changes in economic conditions? This appears to fly in the face of elementary financial theory. Shouldn’t every seller have a distinct target loved one price, depending on real factors, so that when the aggregate price level boosts due to an increase in the money supply, every seller have to adjusts his or she nominal price by the very same amount?

In countless popular macro models, consisting of those used by most policymakers, prices space sticky by assumption, in the feeling that there room either restrictions on how regularly they have the right to change, adhering to Taylor (1980) or Calvo (1983), or there room real source costs to an altering them, complying with Rotemberg (1982) or Mankiw (1985). That is true in principle that a price is incurred in an altering a price—the so-called menu cost—even if this expense is merely a piece of chalk. A notable feature of this models, though, is that at their core they call for a price only for price changes, however ignore all other potential transaction expenses such as transforming one’s quantity, password, apparel or mind. Or they merely impose by decree the a seller can readjust price only at a couple of points in time determined by pure chance.

Stickiness as a result, not presumption

right here we explain a theory that generates price stickiness as a result, no an assumption, even if sellers can change price anytime they choose at no cost. However in solid contrast with theories assuming difficult prices, this theory indicates that money is neutral, so a main bank cannot technician a eight or finish a slump just by printing currency. Our main goal in explicate this concept is not, however, simply to develop that prices room sticky or the money is neutral. Rather, our allude is the the observation of sluggish price mediate does not logically imply that money is nonneutral. Nor does it indicate that we need to emphasis predominately top top macro models that incorporate menu costs or related devices.3

In two recent papers, Head et al. (2012) and Liu et al. (2014), we propose straightforward models with the complying with features. Because of frictions in credit, consisting of lack that commitment and also imperfect surveillance or record keeping, buyers sometimes have to use money. (This part of the concept is based on Lagos and also Wright 2005.4) for the industry in which buyers and sellers trade, us borrow the standard model the frictional an excellent markets arisen by Burdett and Judd (1983). That model, based on search frictions, it is provided price dispersion and has proved beneficial in plenty of other applications, consisting of the large literature on labor markets complying with Burdett and also Mortensen (1998).5

To understand the Burdett-Judd model, it helps to first review the earliest find models, wherein buyers sampled sellers sequentially until they discovered one marketing at a price below the highest possible price buyers to be willing to pay. Burdett and Judd modify Diamond’s (1971) standard search model, which, problematically, had no price dispersion.6 Burdett and also Judd’s one (ostensibly minimal) readjust to the Diamond version is this: quite than sampling price one at a time, together Diamond had it, buyers in the Burdett-Judd model have a positive probability the sampling two or more prices in ~ the very same time. If all sellers set the same price, a the person who lives is indifferent to picking one end another and must use some tie-breaking preeminence to pick. This, that course, gives an separation, personal, instance seller a huge incentive to cut his or her price to gain the sale. In fact, Burdett and Judd uncover that, in the model’s equilibrium, every sellers charge different prices: price dispersion.

once Burdett-Judd pricing is embedded into a financial model, sellers post prices in dollars, because this is exactly how buyers space paying. At any kind of date, there is a selection of posted prices because that which sellers will acquire the exact same profit. While the model pins down the circulation of prices, the does not collection the price for any kind of individual seller. Why not? A short price generates much less profit per sale, but makes up for the low benefit generation v sales volume, due to the fact that a revenue is much more likely from any type of buyer who samples a short price.

If the money supply increases, the equilibrium price circulation shifts up, but this brand-new distribution deserve to overlap v the previous selection of prices. This way that some (but no all) sellers must readjust their prices. If an separation, personal, instance seller’s price falls external the variety of prices that sellers will charge ~ the boost of money supply, it have to adjust; but if it is still in the range of new prices, it might not.

Now, recall the question posed earlier: Shouldn’t every seller have actually a target actual price and, therefore, when the money it is provided increases, shouldn’t every seller readjust his or she nominal price by the same amount? The price is no. Sellers do not have a distinct target price. The model’s equilibrium calls for a circulation of prices, every one of which yield the same profit. If sellers carry out not change their price once money supply increases, they indeed earn much less profit every unit, but again they make it up on the volume. Hence, sellers can change prices infrequently in the challenge of continuous movements in financial conditions, even though they are enabled to change whenever they favor at no cost.

but the critical point is this: policy cannot make use of this price stickiness because the distribution of relative prices is pinned down uniquely. The level the the money supply and the aggregate price level room irrelevant—it is merely a an option of units. This is timeless neutrality.


Our point is that money is not necessarily nonneutral just because prices are sticky. Moreover, a calibrated version of the design can enhance quite fine the empirical behavior of price changes. These points are not widely recognized (or accepted, by those who are aware of them). Ball and Mankiw (1994), to administer a watch representative the a wide segment of the business economics profession, say: “Sticky prices provide the most herbal explanation of monetary nonneutrality because so plenty of prices are, in fact, sticky.” castle add, moreover, that “based top top microeconomic evidence, we think that sluggish price convey is the best explanation for financial nonneutrality,” and “as a matter of logic, in the name stickiness calls for a price of in the name adjustment.”7

We translate these claims by Ball and Mankiw to contain 3 points related, respectively, to empirics, theory and also policy, and our responses to the insurance claims encapsulate our argument regarding monetary neutrality, or lack thereof.

Their an initial claim is that price stickiness is a fact. We agree.

Their 2nd claim is the price stickiness suggests “as a matter of logic” the presence of some technological constraints come price adjustment. The theory outlined above proves this dorn by displaying equilibria that enhance not only the wide observation that stickiness, but the detailed empirical findings, through no such constraints.

Their third claim is the stickiness suggests that money is not neutral and also that this justifies certain policy prescriptions. This is again proved wrong. The concept we’ve just disputed is continuous with the pertinent observations, however money is neutral. Thus, difficult prices execute not constitute definitive proof that money is nonneutral or that specific policy references are warranted.


1 to state this notion with basic math: suppose the economy starts in an equilibrium v money it is provided M, nominal price level P and real allocation (consumption, investment, employment and so on) X. Then adjust M come M′. Over there is currently an equilibrium v price level P′, in i m sorry M′/P′=M/P and X is unchanged. Hence, the readjust in M has actually no impact on anything real.

2 stated mathematically: once M changes to M′, it is not feasible for p to adjust to P′ at the very least in the quick run. Therefore M/P will not stay the same, and also that has real results for X.

3 Our discussion is somewhat analogous to that made by Robert Lucas in his well known 1972 paper. He describes a model constant with the empirical monitoring that over there is a hopeful correlation in between the accumulation price level (or money supply) and output (or employment), but policymakers in this version cannot systematically manipulate the relationship: raising inflation by to press money at a faster rate will certainly not increase average output or employment. Similarly, us argue the one can design a model continuous with observations worrying nominal price adjustment, however it is not feasible for policymakers come systematically make use of this.

4 watch Lagos et al. (2015) for a recent survey of the literary works on monetary economic theory.

5 see Mortensen and also Pissarides (1999) for a inspection of this literature.

6 In Diamond’s model, firms short article prices, bring away as offered the price of others, and then buyers search as described above. This design doesn’t generate price dispersion—problematic because that a theory relying on buyers and also sellers searching for one another. This finding set off a wave of study to generate endogenous price dispersion.

7 somewhat similarly, Golosov and Lucas (2003) say that “menu costs are yes, really there: The truth that countless individual products prices remain fixed because that weeks or month in the face of continuously transforming demand and also supply conditions testifies conclusively to the presence of a fixed expense of repricing.” Our suggest here is not to pick on any details individuals, yet to provide some representative see in the profession.


Ball, L., and N. Mankiw. 1994. “A Sticky-Price Manifesto.” Working record 4677. Nationwide Bureau of financial Research.

Burdett, K., and also K. Judd. 1983. “Equilibrium Price Dispersion.” Econometrica 51, 955-69.

Burdett, K., and also D. Mortensen. 1998. “Wage Differentials, employee Size, and also Unemployment.” International financial Review 39, 257-73.

Calvo, G. 1983. “Staggered price in a Utility-Maximizing Framework.” Journal of financial Economics 12, 383-98.

Diamond, P. 1971. “A version of Price Adjustment.” Journal of economic Theory 2, 156-68.

Golosov, M., and R. Lucas. 2003. “Menu Costs and also Phillips Curves.” Working file 10187. National Bureau of financial Research.

Head, A., L. Liu, G. Menzio and also R. Wright. 2012. “Sticky Prices: A brand-new Monetarist Approach.” Journal of europe Economic Association 10, 939-73.

Klenow, P., and B. Malin. 2010. “Microeconomic evidence on Price-Setting.” In Handbook of financial Economics, B. Friedman and M. Woodford, eds.

Lagos, R., G. Rocheteau and R. Wright. 2015. “Liquidity: A new Monetarist Perspective.” Journal of economic Literature, forthcoming.

Lagos, R., and R. Wright. 2005. “A Unified framework for monetary Theory and also Policy Analysis.” Journal of politics Economy 113, 463-84.

Liu, L., L. Wang and R. Wright. 2014. “Costly Credit and also Sticky Prices.” mimeo.

Lucas, R. 1972. “Expectations and the Neutrality that Money.” Journal of financial Theory 4, 103-24.

Mankiw, N. 1985. “Small Menu prices and large Business Cycles: A Macroeconomic Model.” Quarterly journal of Economics 100, 529-38.

Mortensen, D., and also C. Pissarides. 1999. “New advancements in Models of find in the job Market.” Handbook of job Economics, O. Ashenfelter and also D. Card, eds.

Rotemberg, J. 1982. “Sticky price in the united States.” Journal of politics Economy 90, 1187-1211.

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Taylor, J. 1980. “Aggregate Dynamics and Staggered Contracts.” Journal of political Economy 88, 1-23.