Nonlinear Inflation Dynamics in Menu Cost Economies
September 23, 2024
Summary
Using a multi-product menu cost model, the authors of this working paper reproduce the extent to which the fraction of price changes increases with inflation. In contrast to existing models, the fraction of price changes increases rapidly with the size of monetary shocks, so their model implies a nonlinear Phillips curve.
View PaperWorking Paper 2024-10
Abstract: Existing menu cost models, when parameterized to match the micro-price data, cannot reproduce the extent to which the fraction of price changes increases with inflation. In addition, in the presence of strategic complementarities, they predict implausibly large menu costs and misallocation. We resolve these shortcomings using a multi-product menu cost model that features two key ingredients. First, the products sold by a firm are imperfect substitutes. Second, strategic complementarities are at the firm, not product level. In contrast to existing models, the fraction of price changes increases rapidly with the size of monetary shocks, so our model implies a non-linear Phillips curve.
JEL classification: E12, E31, E32, E52
Key words: menu costs, inflation, Phillips curve
Digital Object Identifier (DOI): https://doi.org/10.29338/wp2024-10
The authors thank Audrey Azerot and Man Chon Iao for superb research assistance, Qazi Haque, Ernesto Pasten, Francisca Sara-Zaror and Ludwig Straub for valuable discussions, as well as Fernando Alvarez, Francesco Lippi and Mark Gertler for useful feedback. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Andrés Blanco, Federal Reserve Bank of Atlanta; Corina Boar, New York University and NBER; Callum Jones, Federal Reserve Board; Virgiliu Midrigan, New York University and NBER.
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