Working Paper 690

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Sticky Prices: A New Monetarist Approach

Allen Head
Lucy Qian Liu
Guido Menzio
Randall Wright - Consultant

Published October 11, 2011

Abstract
Why do some sellers set nominal prices that apparently do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption; here it is a result. We use search theory, with two consequences: prices are set in dollars, since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When the money supply increases, some sellers may keep prices constant, earning less per unit but making it up on volume, so profit stays constant. The calibrated model matches price-change data well. But, in contrast with other sticky-price models, money is neutral.


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