Finance and Economics Discussion Series

Distributional dynamics under smoothly state-dependent pricing

James Costain and Anton Nakov
2011-50

Abstract: Starting from the assumption that firms are more likely to adjust their prices when doing so is more valuable, this paper analyzes monetary policy shocks in a DSGE model with firm-level heterogeneity. The model is calibrated to retail price microdata, and inflation responses are decomposed into "intensive", "extensive", and "selection" margins. Money growth and Taylor rule shocks both have nontrivial real effects, because the low state dependence implied by the data rules out the strong selection effect associated with fixed menu costs. The response to sector-specific shocks is gradual, but inappropriate econometrics might make it appear immediate.

Keywords: Nominal rigidity, state-dependent pricing, menu costs, heterogeneity, Taylor rule