S. Borağan Aruoba, Eugene Oue, Felipe Saffie, and Jonathan L. Willis
Working Paper 2023-3a
April 2023 (Revised June 2024)
Abstract:
We develop a simple menu-cost model with non-constant elasticity of demand that features idiosyncratic productivity and demand shocks. The model is calibrated to match firm-level productivity and demand processes estimated from US data. Despite its simplicity, the calibrated model delivers untargeted pricing dynamics and a markup distribution that are consistent with US micro data. Moreover, it also generates sizable monetary non-neutrality that rivals more complicated alternative menu cost models that explicitly target pricing dynamics. The key in reconciling firm and pricing dynamics comes from the interaction between non-constant elasticity of demand and idiosyncratic demand shocks. Thus, this framework effortlessly unifies pricing, markup, and firm dynamics.
JEL classification: E30, E52, L11
Key words: menu costs, strategic complementarities, demand shocks, sticky prices, monetary non-neutrality
https://doi.org/10.29338/wp2023-03
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. The authors would like to thank Laura Castillo-MartÃnez (discussant), John Haltiwanger, Pete Klenow, Virgiliu Midrigan, Luminita Stevens, Javier Turén, and seminar participants at the University of Maryland, the Federal Reserve Board of Governors, the University of Iowa, Georgetown University, PUC-Chile, Michigan State University, the European Central Bank, the Deutsche Bundesbank, the European University Institute, and North Carolina State University for useful comments and suggestions.
S. Borağan Aruoba is with the University of Maryland. Eugene Oue is with Hong Kong Polytechnic University. Felipe Saffie is with the University of Virginia's Darden School of Business. Please address questions regarding content to Jonathan L. Willis, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree St. NE, Atlanta, GA 30309.
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