COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1603 Price Stickiness in Ss Models: New Interpretations of Old Results Ricardo J. Caballero and Eduardo M.R.A. Engel February 2007 What is the relation between infrequent price adjustment and the dynamic response of
the aggregate price level to monetary shocks? The answer to this question ranges from a
one-to-one link (Calvo, 1983) to no connection whatsoever (Caplin and Spulber, 1987). The
purpose of this paper is to provide a unified framework to understand the mechanisms
behind this wide range of results. In doing so, we propose new interpretations of key
results in this area, which in turn suggest the kind of Ss model that is likely
to generate substantial price rigidity. The first result we revisit is Caplin and
Spulber's monetary neutrality model. We show that when price stickiness is measured in
terms of the impulse response function, this result is not a consequence of aggregation,
but is due instead to the absence of price-stickiness at the microeconomic level. We also
show that the “selection effect,” according to which units that adjust their
prices are those that benefit the most, is neither necessary nor sufficient to account for
the higher aggregate flexibility of Ss-type models compared to Calvo models.
Instead, the key concept is the contribution of the extensive margin of adjustment
to the aggregate price response. The aggregate price level is more flexible than suggested
by the microeconomic frequency of adjustment if and only if this term is positive. |
