Setting the right prices for the wrong reasons

Abstract

We consider a model of nominal price adjustment with firm-specific and aggregate shocks to economic fundamentals and incomplete, dispersed information. Firms update their expectations about fundamentals based on their own cash flows (revenues and wages). We show that in a model with realistic levels of product-level price dispersion, the firms' inference about aggregate shocks is very gradual, yet in the aggregate prices adjust rapidly in response to aggregate nominal shocks. When an aggregate shock occurs, firms mistakenly attribute it to firm-specific shocks, but adjust prices nevertheless, since the exact nature of the shock matters little for its optimal pricing decision.

Business Cycle Dynamics under Rational Inattention

“…In the following, we work with loglinearized equations for aggregate variables. Log-linearizing the equations for aggregate output (8), aggregate composite consumption (12), and aggregate composite labor input (13) yields …”

Why do forecasters disagree? Lessons from the term structure of cross-sectional dispersion

“…which exploits the stationarity of this process, and yields an implicit solution for the covariance of nowcast errors across forecasters, P 0ik : 18 Thus the variance of the error of the consensus nowcast of the state vector is:…”

“…Moreover, a better understanding of what determines heterogeneity in agents' beliefs and how this heterogeneity evolves over time can facilitate sharper tests of macroeconomic models for which subjective beliefs are a driver of economic activity. This point is highlighted by the sensitivity of some of the conclusions drawn from models with heterogeneous information to the type of signals observed by agents (e.g., Hellwig and Venkateswaran (2009)). …”

Monetary Policy Activism and Price Responsiveness to Aggregate Shocks under Rational Inattention

“…This implies a degree of real rigidity = 0:32: 14 The discount factor is set to = 0:993; so to have an annual nominal interest rate in steady state equal to 3 percent.…”

“…13 See Appendix E for detalis. 14 Notice that this is a conservative calibration of : In the new-Keynesian literature the parameter is often set at lower values. For instance, Woodford [27] suggest values of between 0.1 and 0.15.…”