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Abstract:
A model that contains no costs to changing prices but in which prices do not respond to nominal
shocks is presented. In models that do not feature superneutrality of money flexible price equilibria will allow
certain types of monetary shocks to affect the real economy. Sticky price behavior may in fact be better at
protecting the real economy from the effects of monetary shocks in such environments. This point is
demonstrated in a standard monetary model with liquidity effects. An equilibrium in which sticky prices are
supported without menu costs is then constructed. In equilibrium firms choose to keep prices fixed in
response to nominal shocks because doing so provides a service to their customers, increasing profits by
expanding the customer base.
Full paper (361 KB PDF)
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