DP5749 Menu Costs and Asymmetric Price Adjustment

Author(s): Tore Ellingsen , Richard Friberg , John Hassler

Publication Date: July 2006

Keyword(s): asymmetric price adjustment , downward rigidity , menu costs , Phillips curve

JEL(s): D42 , E31 , E32

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP5749.asp.asp

We study optimal price setting by a monopolist in an infinite horizon model with stochastic costs, moderate inflation, and costly price adjustment. For realistic parameters, chosen to replicate observed frequencies of price changes, the model fits numerically several empirical regularities. In particular, price reductions are larger but less frequent than price increases, and prices respond considerably faster to cost increases than to cost decreases. The associated kink in the steady state short-run Phillips curve implies that the output loss associated with a small negative inflation surprise is about twice as large as the output gain associated with a small positive inflation surprise.