Optimally Sticky Prices

By William Zame and Jean-Paul L’Huillier

http://d.repec.org/n?u=RePEc:red:sed015:621&r=dge

We propose a microfoundation for sticky prices. We consider a an environment in which a monopolistic firm has better information than its consumers about the nominal aggregate state. We show that, when many consumers are uninformed (and for some ranges of parameters), it is optimal for the firm to offer contracts/prices that do not depend on the state of the world; i.e. optimal contracts/prices are sticky. We establish this result first in a general mechanism design framework that allows for non-linear pricing and screening, and then show implementation under both contract-setting and price-setting. A virtue of our microfoundation is that it is compatible with a dynamic general equilibrium model with money. We analyze whether money is neutral in this framework, and discuss the implications of this microfounded friction for welfare.

Very ambitious and much needed work. Whether this model will stick or not will unfortunately depend on how easy it is to stick it in standard models…

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