Price plans and the real effects of monetary policy
Abstract:
Transitory price changes are prominent in t
he data but do not fit neatly in standard sticky price models. We present a
model where a firm chooses a “price plan”, namely a set of 2 prices each o
f which can be freely posted at each moment. While price changes between pr
ices within the plan are free, the plan can be changed only subject to a fi
xed menu cost. This setup generates a persistent “reference”
price le
vel and short lived deviations from it, as seen in many datasets. The model
also produces a decreasing hazard function for price changes, a feature th
at appears in several datasets. We analytically solve for the optimal polic
y of a firm, and for the cumulative impulse response function of output to
a once and for all monetary shock. We compare the economy with the 2-price
plan to a menu-cost economy (i.e. a plan with 1 price) featuring the same n
umber of persistent price changes. We show that, for a small monetary shock
, the introduction of a plan with 2 prices yields a cumulative output respo
nse that is 1/3 of the one produced by the menu cost economy. The smaller r
eal effect of the monetary shock is due to the flexibility delivered by the
temporary price changes which are used by the firms to respond to the aggr
egate shock.