DP12638 Temporary Price Changes, Inflation Regimes and the Propagation of Monetary Shocks

Author(s): Fernando Alvarez, Francesco Lippi
Publication Date: January 2018
Keyword(s): menu cost models, price flexibility, price plans, reference prices, sticky prices, temporary price changes
JEL(s): E3, E5
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12638

We analyze a sticky price model where firms choose a price plan, namely a set of two prices. Changing the plan entails a "menu cost", but either price in the plan can be charged at any point in time. We analytically solve for the optimal policy and for the output response to a monetary shock. The setup rationalizes the coexistence of many price changes, most of which are temporary, with a modest flexibility of the aggregate price level. We present evidence consistent with the model implications using CPI data for Argentina across a wide range of inflation rates.