Even if prices are slow to adjust, this no necessarily median that monetary policy can be offered to wake up or slow economic activity



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many economists think that prices are “sticky”—they adjust slowly. This stickiness, castle suggest, way that changesin the money supply have actually an affect on the genuine economy, inducing transforms in investment, employment, output and consumption, an result that have the right to be exploited through policymakers.

In this essay, we argue the price stickiness doesn’t necessarily create an exploitable policy option. We explain a version in i beg your pardon money is neutral (that is, expansion or reduction in moneysupply doesn’t impact real financial activity) also in a context of slow price adjustment.


below are 2 venerable questions in macroeconomic theory and policy analysis: space prices sticky? Does it matter?

through “sticky” prices, we mean the observation that some sellers collection prices in nominal state that carry out not adjust quickly in solution to transforms in the aggregate price level or to alters in economic conditions much more generally. Part macroeconomics together taught in the classroom and used in practice makes the presumption that nominal prices room sticky and then proceeds come derive policy implications. In this essay, we desire to difficulty the idea the these policy effects are necessarily correct (even if price are sticky).

classic macroeconomics embodied the idea that money is neutral—that is, enhancing or decreasing the amount of money in an economic climate has no impact on real economic activity such as investment, production, usage or hiring. If money is neutral, it is no clear what monetary policy can do.1

Some economists dispute classic neutrality. Lock argue that nominal prices space sticky, at the very least in the short run, and also that this has far-reaching consequences because that the actual economy.2 The exact consequences depend on details, but many models the this institution of thought have actually this effect: If buyers have an ext money and sellers keep their prices the same, the previous will demand more goods and services and also the latter (by assumption) will certainly supply them. This generates boost in investment, employment, output and also consumption.

The counterargument is that putting much more cash in people’s hand is like including a zero to every bill; that is, a one-dollar bill becomes a 10-dollar bill, a 10 becomes a 100 and also so on. Some economic experts say the this candlestick not have actually a genuine impact, any more than transforming the way temperature is measured from Fahrenheit to Celsius would—it’s simply units!

many economists suggest out, however, that sticky prices space what us observe empirically and, indeed, there is an element of reality in their discussion (see Klenow and also Malin 2010 because that a inspection of empirical work). Then we can ask, why do some sellers collection prices in nominal state that execute not adjust in solution to transforms in economic conditions? This seems to paris in the face of elementary economic theory. Shouldn’t every seller have actually a distinctive target family member price, depending upon real factors, so that once the aggregate price level rises due to an increase in the money supply, every seller necessarily adjusts his or her nominal price by the very same amount?

In many popular macro models, consisting of those supplied by many policymakers, prices are sticky by assumption, in the feeling that there are either constraints on how often they deserve to change, complying with Taylor (1980) or Calvo (1983), or there room real source costs to an altering them, following Rotemberg (1982) or Mankiw (1985). The is true in principle that a expense is incurred in an altering a price—the so-called food selection cost—even if this expense is just a item of chalk. A notable attribute of these models, though, is the at their core they call for a cost only for price changes, however ignore all various other potential transaction expenses such as an altering one’s quantity, password, apparel or mind. Or they merely impose through decree the a seller can adjust price just at a few points in time established by pure chance.

Stickiness together a result, not presumption

here we explain a concept that generates price stickiness as a result, not an assumption, also if sellers can change price at any time they like at no cost. Yet in solid contrast with theories assuming sticky prices, this theory suggests that money is neutral, therefore a central bank cannot engineer a eight or finish a slump merely by print currency. Our main goal in describing this concept is not, however, just to establish that prices are sticky or the money is neutral. Rather, our point is the the observation of slow-moving price mediate does no logically imply that money is nonneutral. Nor does it imply that we require to emphasis predominately ~ above macro models the incorporate menu costs or related devices.3

In two current papers, Head et al. (2012) and Liu et al. (2014), we propose an easy models v the following features. Because of frictions in credit, consisting of lack of commitment and imperfect monitoring or document keeping, buyers sometimes have to use money. (This component of the theory is based upon Lagos and also Wright 2005.4) because that the industry in i m sorry buyers and sellers trade, us borrow the classic model of frictional good markets occurred by Burdett and Judd (1983). That model, based on search frictions, it is intended price dispersion and also has proved useful in many other applications, including the big literature on labor markets complying with Burdett and also Mortensen (1998).5

To recognize the Burdett-Judd model, it helps to an initial review the earliest search models, where buyers sampled sellers sequentially until they discovered one selling at a price listed below the highest price buyers to be willing to pay. Burdett and Judd modify Diamond’s (1971) standard search model, which, problematically, had actually no price dispersion.6 Burdett and Judd’s one (ostensibly minimal) adjust to the Diamond model is this: rather than sampling prices one at a time, as Diamond had actually it, buyers in the Burdett-Judd model have actually a optimistic probability that sampling 2 or an ext prices in ~ the very same time. If all sellers set the very same price, a buyer is indifferent to picking one end another and also must usage some tie-breaking preeminence to pick. This, that course, offers an individual seller a substantial incentive to cut his or she price to get the sale. In fact, Burdett and also Judd discover that, in the model’s equilibrium, all sellers charge various prices: price dispersion.

once Burdett-Judd pricing is embedded into a financial model, sellers write-up prices in dollars, because this is how buyers are paying. At any type of date, there is a range of post prices for which sellers will obtain the very same profit. If the model pins down the distribution of prices, that does not set the price for any kind of individual seller. Why not? A low price generates less profit per sale, yet makes increase for that low benefit generation with sales volume, since a revenue is much more likely from any kind of buyer that samples a low price.

If the money it is provided increases, the equilibrium price distribution shifts up, yet this brand-new distribution deserve to overlap v the previous variety of prices. This means that part (but not all) sellers must adjust their prices. If an separation, personal, instance seller’s price falls external the variety of prices the sellers will charge after the rise of money supply, it must adjust; yet if that is still in the range of new prices, it might not.

Now, recall the concern posed earlier: Shouldn’t every seller have actually a target genuine price and, therefore, when the money supply increases, shouldn’t every seller adjust his or she nominal price by the very same amount? The answer is no. Sellers perform not have actually a unique target price. The model’s equilibrium requires a circulation of prices, every one of which productivity the exact same profit. If sellers carry out not readjust their price once money supply increases, they certainly earn less profit per unit, however again they do it increase on the volume. Hence, sellers can adjust prices infrequently in the face of continuous movements in economic conditions, even though castle are allowed to readjust whenever they favor at no cost.

yet the vital point is this: policy cannot manipulate this price stickiness due to the fact that the distribution of relative prices is pinned down uniquely. The level of the money supply and the aggregate price level are irrelevant—it is merely a an option of units. This is timeless neutrality.


Our suggest is the money is no necessarily nonneutral just due to the fact that prices space sticky. Moreover, a calibrated variation of the model can enhance quite well the empirical behavior of price changes. These points space not widely recognized (or accepted, by those who are conscious of them). Ball and also Mankiw (1994), to administer a see representative of a large segment that the business economics profession, say: “Sticky prices provide the most organic explanation of monetary nonneutrality because so numerous prices are, in fact, sticky.” they add, moreover, the “based ~ above microeconomic evidence, we believe that sluggish price adjustment is the best explanation for financial nonneutrality,” and also “as a issue of logic, nominal stickiness needs a cost of nominal adjustment.”7

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

Their very first claim is the price stickiness is a fact. Us agree.

Their second claim is that price stickiness implies “as a issue of logic” the presence of some technological constraints to price adjustment. The theory outlined over proves this not correct by displaying equilibria that match not only the vast observation the stickiness, however the thorough empirical findings, v no such constraints.

Their 3rd claim is that stickiness means that money is not neutral and that this justifies details policy prescriptions. This is again proved wrong. The theory we’ve just discussed is constant with the appropriate observations, yet money is neutral. Thus, difficult prices do not constitute definitive evidence that money is nonneutral or that particular policy recommendations are warranted.


1 come state this notion with simple math: expect the economic climate starts in one equilibrium with money it is provided M, in the name of price level P and also real assignment (consumption, investment, employment and also so on) X. Then change M to M′. There is now an equilibrium through price level P′, in i m sorry M′/P′=M/P and also X is unchanged. Hence, the readjust in M has no result on something real.

2 declared mathematically: as soon as M alters to M′, that is not feasible for ns to readjust to P′ at least in the short run. Because of this M/P will certainly not remain the same, and also that has actually real consequences for X.

3 Our discussion is somewhat analogous to that made by Robert Lucas in his famed 1972 paper. He defines a model consistent with the empirical monitoring that there is a positive correlation between the accumulation price level (or money supply) and also output (or employment), but policymakers in this model cannot systematically make use of the relationship: boosting inflation by to press money at a much faster rate will certainly not increase average output or employment. Similarly, us argue the one can architecture a model consistent with observations concerning nominal price adjustment, but it is not possible for policymakers come systematically make use of this.

4 view Lagos et al. (2015) because that a current survey of the literary works on monetary economic theory.

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

6 In Diamond’s model, firms write-up prices, bring away as given the prices of others, and then buyers find as explained above. This version doesn’t create price dispersion—problematic because that a theory depending upon buyers and sellers in search of one another. This finding set off a wave of research study to create endogenous price dispersion.

7 somewhat similarly, Golosov and also Lucas (2003) say that “menu costs are yes, really there: The fact that countless individual goods prices continue to be fixed for weeks or months in the confront of continuously changing demand and also supply conditions testifies conclusively come the visibility of a fixed cost of repricing.” Our suggest here is not to choose on any particular individuals, however to provide some representative see in the profession.


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

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

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

Calvo, G. 1983. “Staggered prices in a Utility-Maximizing Framework.” Journal of monetary 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 document 10187. National Bureau of financial Research.

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

Klenow, P., and also 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 financial Literature, forthcoming.

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

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

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

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

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

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

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