DP11790 Menu costs, the price gap distribution and monetary non-neutrality: The role of financial constraints

Author(s):	Almut Balleer, Nikolay Hristov, Dominik Menno
Publication Date:	January 2017
Date Revised:	August 2020
Keyword(s):	Financial Frictions, Frequency of price adjustment, menu cost model
JEL(s):	E31, E44
Programme Areas:	Monetary Economics and Fluctuations
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=11790

We study how credit constraints and the frequency of price adjustment interact. We show that a working capital constraint increases the kurtosis of the price change distribution and generates small and large price changes to co-exist in a menu cost model. Our model is consistent with firm- level evidence for Germany that relates financial constraints to the frequency and direction of price changes. Financial frictions change the propagation of aggregate nominal shocks: The frequency of price adjustments fluctuates and the average price-adjustment size falls weakening the selection effect. Monetary non-neutrality only increases when the overall level of price adjustment falls.