DP9770 Small and large price changes and the propagation of monetary shocks

Author(s):	Fernando Alvarez, Hervé Le Bihan, Francesco Lippi
Publication Date:	December 2013
Keyword(s):	Calvo pricing rule, distribution of price changes, menu cost, micro evidence, monetary shocks, rice setting
JEL(s):	E3, E5
Programme Areas:	International Macroeconomics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=9770

We document the presence of both small and large price changes in individual price records from the CPI in France and the US. After correcting for measurement error and cross-section heterogeneity we find that the size distribution of price changes has a positive excess kurtosis, with a shape that lies between a Normal and a Laplace distribution. We propose a model, featuring random menu-costs and multi product firms, that is capable to reproduce the observed empirical patterns. We characterize analytically the response of the aggregate economy to a monetary shock. Different propagation mechanism, spanning the models of Taylor (1980), Calvo (1983) and Golosov and Lucas (2007), are nested under different combination of 4 fundamental parameters. We dis- cuss the identification of these parameters using data on the size-distribution of price changes and the actual cost of price adjustments borne by firms. The output effect is proportional to the ratio of kurtosis to the frequency of price changes.