Nominal rigidity
In 1936, John Maynard Keynes published The General Theory of Employment, Interest and Money. Within its pages, he described a situation where nominal wages display downward rigidity. Workers are reluctant to accept cuts in their pay. This resistance creates involuntary unemployment as wages fail to adjust to equilibrium levels quickly enough. Complete nominal rigidity occurs when a price remains fixed for a relevant period. A contract might set the price of a good at $10 per unit for an entire year regardless of supply changes. Partial nominal rigidity allows prices to adjust but less than under perfect flexibility. Legal limits in regulated markets may restrict how much a price can change within a given year. These rigidities explain why markets do not always clear immediately.
Statistical agencies collect tens of thousands of price quotes each month to construct the Consumer Price Index. In France and the UK during the late 1990s, 19% of prices changed every month on average. This implies that an average price spell lasts about 5.3 months. US data from 1998 to 2005 showed similar patterns with slight variations across countries like Germany and Italy. Removing temporary sales raises the mean spell duration considerably. In the United States, the reference price remained unchanged for an average of 14.5 months after excluding sales. Some items like gasoline vary frequently resulting in many short price spells. Other goods such as champagne or restaurant meals stay fixed for extended periods. The distribution of durations heavily influences our understanding of economic behavior rather than simple averages alone.
John B. Taylor published a paper in 1980 describing firms that change prices every nth period. Guillermo Calvo followed with a model in 1983 where price changes follow a Poisson process. Time-dependent models assume firms decide to change prices independently of the economic environment. A fixed percentage of firms reset their price at any given time without selection criteria. State-dependent models link decisions to menu costs. Firms change prices when benefits exceed the cost of changing them. Golosov and Lucas proposed one state-dependent model while Dotsey, King and Wolman suggested another. Prices change faster under state-dependent approaches because they respond directly to market conditions. Monetary shocks are over more quickly when flexibility drives the decision making process.
Huw Dixon and Claus Hansen demonstrated how sticky prices influence other sectors. Even if only part of the economy has rigid prices, this can lead to less responsiveness across the rest of the system. In a perfectly flexible economy, monetary shocks would lead to immediate changes in nominal prices leaving real quantities unaffected. This concept is sometimes called monetary neutrality or the neutrality of money. Neoclassical models predict involuntary unemployment should not exist since employers would cut wages until equilibrium returns. Sticky wages explain why workers cannot find jobs when demand drops. The presence of fixed prices ties down flexible ones through aggregate interactions. Changes in nominal demand feed through into output changes for both sectors regardless of initial rigidity levels.
Stanley Fischer developed the first model of sticky information in his 1977 article. He adopted a staggered contract model where two unions take turns choosing wages for future periods. At any time t, one union uses up-to-date latest information while the other relies on old data from last period contracts. N. Gregory Mankiw and Ricardo Reis later added a feature allowing firms to replan with a fixed probability each quarter. They assumed 25% of randomly chosen firms could plan trajectories based on current information. This model explains inflation persistence by showing how some sectors react to new events while others lag behind. Firms remain free to choose different prices but rely on outdated information for decision making.
Charles I. Jones wrote about sticky inflation in his 2013 textbook Macroeconomics. When firms set prices they respond slowly to monetary policy changes causing gradual rate adjustments. Stagflation occurs when economic output decreases while inflation increases simultaneously. Home prices prior to the recession serve as an example of expected inflation driving this dynamic. Wage push inflation results from negotiated raises that fail to adjust quickly enough. Monetary expansion or contraction can both have negative effects on living standards during these periods. The classical dichotomy does not hold when sticky inflation is present affecting real variables. Attempts now formulate dual stickiness models combining rigid prices with delayed information updates to match empirical evidence.
Common questions
When did John Maynard Keynes publish The General Theory of Employment Interest and Money?
John Maynard Keynes published The General Theory of Employment Interest and Money in 1936. This work described a situation where nominal wages display downward rigidity as workers resist pay cuts.
What percentage of prices changed every month on average in France and the UK during the late 1990s?
In France and the UK during the late 1990s, 19% of prices changed every month on average. This implies that an average price spell lasts about 5.3 months before changing again.
Who published a paper in 1980 describing firms that change prices every nth period?
John B. Taylor published a paper in 1980 describing firms that change prices every nth period. Guillermo Calvo followed with a model in 1983 where price changes follow a Poisson process.
How does sticky information explain inflation persistence according to N. Gregory Mankiw and Ricardo Reis?
N. Gregory Mankiw and Ricardo Reis added a feature allowing firms to replan with a fixed probability each quarter. They assumed 25% of randomly chosen firms could plan trajectories based on current information while others rely on outdated data from last period contracts.
When did Charles I. Jones write about sticky inflation in his textbook Macroeconomics?
Charles I. Jones wrote about sticky inflation in his 2013 textbook Macroeconomics. He explained how firms set prices slowly in response to monetary policy changes causing gradual rate adjustments.
All sources
21 references cited across the entry
- 1journalWhat We can Learn About the Behaviour of Firms from the Average Monthly Frequency of Price-Changes: An Application to the UK CPI DataHuw David Dixon et al. — 2017
- 2journalIntegrating Sticky Prices and Sticky InformationL Baudry et al. — 2007
- 3journalPrices are sticky after allPatrick Kehoe et al. — 2016
- 4journalFive facts about prices: a reevaluation of menu cost modelsEli Nakamura et al. — 2008
- 5journalPrice rigidity and price dispersion: evidence from micro dataEyal Baharad et al. — 2004
- 6journalEvaluating Microfoundations for Aggregate Price Rigidities: Evidence from Matched Firm-Level Data on Product Prices and Unit Labor CostMikael Carlsson et al. — 2012
- 7journalAggregate Dynamics and Staggered ContractsJohn B. Taylor — 1980
- 8journalStaggered Prices in a Utility-Maximizing FrameworkGuillermo A. Calvo — 1983
- 9journalState-Dependent or Time-Dependent Pricing: Does It Matter For Recent U.S. Inflation?Peter J. Klenow et al. — 2008
- 10journalMenu Costs and Phillips CurvesMikhail Golosov et al. — 2007
- 11journalState-Dependent Pricing and the General Equilibrium Dynamics of Money and OutputMichael Dotsey et al. — 1999
- 12journalA mixed industrial structure magnifies the importance of menu costsHuw Dixon et al. — 1999
- 13journalNominal wage flexibility in a partly unionised economyHuw Dixon — 1992
- 14journalMacroeconomic Price and Quantity responses with heterogeneous Product MarketsHuw Dixon — 1994
- 15journalLong-Term Contracts, Rational Expectations, and the Optimal Money Supply RuleS. Fischer — 1977
- 16journalSticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips CurveN. G. Mankiw et al. — 2002
- 17journalNew Keynesian Models: Not Yet Useful for Policy AnalysisV. V. Chari et al. — 2008
- 18journalA Tale of Two Rigidities: Sticky Prices in a Sticky-Information EnvironmentEdward S. II Knotec — 2010
- 19journalSticky Prices in the Euro Area: A Summary of New Micro-EvidenceLuis J. Álvarez et al. — 2006
- 20journalExamining The Behaviour Of Individual UK Consumer PricesPhilip Bunn et al. — 2012
- 21journalIntegrating Sticky Prices and Sticky InformationBill Dupor et al. — 2010