DP10731 Logit Price Dynamics

Author(s): James Costain, Anton Nakov
Publication Date: July 2015
Keyword(s): information-constrained prices, logit equilibrium, near rationality, nominal rigidity, state-dependent pricing
JEL(s): C73, D81, E31
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10731

We model retail price stickiness as the result of errors due to costly decision-making. Under our assumed cost function for the precision of choice, the timing of price adjustments and the prices firms set are both logit random variables. Errors in the prices firms set help explain micro ?puzzles? relating to the sizes of price changes, the behavior of adjustment hazards, and the variability of prices and costs. Errors in adjustment timing increase the real effects of monetary shocks, by reducing the ?selection effect?. Allowing for both types of errors also helps explain how trend inflation affects price adjustment.