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Title: Menu Costs, Aggregate Fluctuations, and Large Shocks

Author(s): Peter Karadi and Adam Reiff

Publication Date: September 2014

Keyword(s): monetary policy transmission, price change distribution, state-dependent pricing and value-added tax

Programme Area(s): International Macroeconomics

Abstract: How do frictions in price setting influence monetary non-neutrality? We revisit this classic question in a quantitative menu cost model with multi-product firms that face idiosyncratic shocks with unsynchronized stochastic volatility. The model matches the unconditional distribution of price changes and successfully predicts new evidence on pricing responses to large value-added tax shocks. In particular, it captures both the exploding fraction of price changes and the shape of their conditional distribution, outperforming alternative models. The model generates near money neutrality even to small nominal shocks.

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Bibliographic Reference

Karadi, P and Reiff, A. 2014. 'Menu Costs, Aggregate Fluctuations, and Large Shocks'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10138