Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty / Cosmin L. Ilut, Rosen Valchev, Nicolas Vincent.

Format:

Book

Author/Creator:

Ilut, Cosmin L.

Contributor:

National Bureau of Economic Research.

Valchev, Rosen.

Vincent, Nicolas.

Series:

Working Paper Series (National Bureau of Economic Research) no. w22490.

NBER working paper series no. w22490

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Paralyzed by Fear

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2016.

Summary:

We propose a new theory of price rigidity based on firms' Knightian uncertainty about their competitive environment. This uncertainty has two key implications. First, firms learn about the shape of their demand function from past observations of quantities sold. This learning gives rise to kinks in the expected profit function at previously observed prices, making those prices both sticky and more likely to reoccur. Second, uncertainty about the relationship between aggregate and industry-level inflation generates nominal rigidity. We prove the main insights analytically and quantify the effects of our mechanism. Our estimated quantitative model is consistent with a wide range of micro-level pricing facts that are typically challenging to match jointly. It also implies significantly more persistent monetary non-neutrality than in standard models, allowing it to generate large real effects from nominal shocks.

Notes:

Print version record

August 2016.