Working Papers

2012

 

December 2012, No. 12-09R

Selection and Monetary Non-Neutrality in Time-Dependent Pricing Models (Revised March 2013)

Carlos Carvalho and Felipe Schwartzman

Given the frequency of price changes, the real effects of a monetary shock are smaller if adjusting firms are disproportionately likely to be ones with prices set before the shock. We show that, for a given frequency of price changes, this selection effect provides a complete characterization of the distribution of price durations in time-dependent sticky-price models. We find that: 1) Selection is stronger and real effects of monetary shocks are smaller if the hazard function of price adjustment is more strongly increasing; 2) Selection is weaker and real effects are larger if there is sectoral heterogeneity in price stickiness; 3) Selection is stronger and real effects are smaller if the durations of price spells are less variable. We also show that 4) If monetary shocks affect primarily the level of nominal aggregate demand, the mean and variance of price durations are sufficient statistics for the real effects of such shocks.

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