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Nominal rigidity

Nominal rigidity, also termed price or wage stickiness, denotes the tendency of nominal prices and wages to adjust slowly or infrequently in response to shifts in economic fundamentals, such as changes in aggregate demand, supply, or monetary conditions, thereby impeding rapid market clearing.^[1] This friction arises from microeconomic adjustment costs and coordination challenges among agents, distinguishing it from real rigidities that involve relative price inflexibility independent of the overall price level.^[1] In macroeconomic theory, nominal rigidity underpins the non-neutrality of money, enabling nominal shocks—like unanticipated changes in the money supply—to exert lasting influence on real variables such as output and employment, a core feature of New Keynesian frameworks that incorporate staggered price-setting mechanisms like Calvo or Taylor contracts.^[1] Empirical evidence from disaggregated price data, including U.S. Consumer Price Index micro-records spanning 1988–2005, documents infrequent adjustments: regular prices exhibit median monthly change frequencies of 9.9% to 13.9%, implying durations of 7.2 to 9.6 months, while including temporary sales shortens posted price durations to 3.7–4.4 months.^[1] Producer prices display comparable patterns, with sectoral variation—such as high flexibility in energy versus low in services—highlighting heterogeneity that aggregate models must accommodate.^[1] Proposed microfoundations include menu costs, representing fixed expenses (around 0.5% of revenue) for reprinting catalogs or reprogramming systems, alongside state-dependent pricing thresholds and strategic complementarities where firms delay changes awaiting peers' actions; however, scanner data analyses question menu costs as the primary driver, pointing instead to psychological price points (e.g., nine-ending prices) and synchronization patterns that persist even absent literal adjustment frictions.^[1]^[2] Nominal rigidities feature prominently in explaining business cycle dynamics and monetary policy efficacy, as rigid prices amplify demand-side fluctuations by muting aggregate supply responses, yet quantitative calibrations reveal that only modest rigidity—far less than full-year durations—generates empirically plausible persistence in real effects from monetary shocks when paired with variable markups or other real frictions.^[3] This has fueled debates, with critics arguing that observed micro-level stickiness alone understates flexibility in high-inflation episodes and over-relies on assumed coordination failures to rationalize macro sluggishness, prompting refinements in models to better align with data on sales, heterogeneity, and wage rigidities.^[3]^[1]

Definition and Basic Concepts

Core Definition and Distinction from Real Rigidities

Nominal rigidity refers to the reluctance or slowness of nominal prices and wages—expressed in monetary units—to adjust fully and promptly to shifts in economic fundamentals such as supply, demand, or productivity.^[4] This phenomenon implies that money is not neutral in the short run, as changes in the money supply can influence real output and employment by altering relative real prices indirectly through persistent nominal frictions.^[5] Empirical studies, including micro-level price data from consumer and producer surveys, document that individual prices change infrequently, with average durations of 8 to 11 months between adjustments in many economies, supporting the prevalence of such stickiness over flexible-price benchmarks.^[6] In contrast, real rigidities arise from structural features of the real economy that impede adjustments in relative prices or quantities, independent of monetary denomination, such as monopolistic competition, capacity constraints, or labor market search frictions that limit factor reallocation.^[5] For instance, under monopolistic competition, firms face downward-sloping demand curves, creating incentives to maintain markups that resist changes in relative prices even absent nominal frictions; these real factors amplify the aggregate effects of nominal rigidities by fostering strategic complementarities, where one firm's price adjustment depends on others'.^[6] While nominal rigidities alone might lead to dispersed price changes without strong macroeconomic propagation, real rigidities ensure that nominal stickiness translates into persistent deviations from efficient resource allocation, as seen in models where micro-level real costs of relative price movements (e.g., via variable markups) interact with nominal menu costs.^[4] This distinction underscores that nominal rigidities operate through monetary transmission, whereas real rigidities stem from non-monetary production or market imperfections, though both contribute to observed business cycle inertia in New Keynesian frameworks.^[7] Menu costs refer to the fixed transaction costs that firms incur when altering their nominal prices, such as expenses for reprinting catalogs, reprogramming point-of-sale systems, or negotiating with suppliers.^[8] These costs, though small relative to a firm's output—often estimated at 0.1% to 1% of sales—can deter frequent price adjustments, resulting in nominal price stickiness.^[9] The concept was formalized by Eytan Sheshinski and Yoram Weiss in their 1977 model of optimal pricing under inflation, where monopolistically competitive firms face convex adjustment costs and choose (S, s) pricing bands, adjusting prices only when deviations from optimal levels exceed thresholds driven by inflation and demand shocks.^[10] In state-dependent pricing models incorporating menu costs, firms weigh the benefit of realigning prices against the fixed cost, leading to infrequent but larger adjustments; this generates aggregate price rigidity even with low individual costs, as synchronized inaction across firms amplifies deviations from equilibrium.^[9] For instance, Sheshinski and Weiss (1983) extended their framework to show that under steady inflation, the amplitude of real price fluctuations increases with adjustment costs, while the frequency of changes rises, but nominal rigidity persists due to lumpy repricing.^[11] Subsequent work, such as Caplin and Spulber (1987), demonstrated that under certain conditions—like uniform firm sizes and Poisson-distributed shocks—menu costs may not propagate to aggregate rigidity, challenging early claims; however, empirical deviations from these assumptions, including heterogeneous firm responses, restore the link to macroeconomic stickiness.^[12] Empirical studies confirm menu costs' role in price stickiness. Macroeconometric analyses using disaggregated consumer price data indicate average price durations of 4 to 12 months across goods, with menu costs explaining up to 30 days of observed rigidity in euro-area retail prices during currency transitions.^[13] Micro-level evidence from firm-level datasets shows that higher menu cost proxies—such as variation in physical adjustment expenses—correlate with 13.3% fewer price increases following cost shocks, particularly in sectors with high fixed costs like services.^[14] Stock market reactions to announcements of sticky-price firms further suggest these frictions impose real costs, as investors penalize non-adjusting firms with lower returns, implying menu costs encompass informational and strategic barriers beyond mere physical expenses.^[15] Adjustment frictions extend menu costs to broader barriers in nominal variable changes, including contractual lags, information processing delays, and financial constraints that raise the effective cost of repricing.^[16] In dynamic stochastic general equilibrium models, these frictions interact with menu costs to heighten nominal rigidity; for example, financially constrained firms exhibit greater price inertia, as credit limits amplify the opportunity cost of adjustment funds.^[16] Empirical wage data reveal similar frictions, with nominal adjustments clustering at year-ends due to contract renegotiation costs, contributing to downward rigidity where wages resist cuts despite excess supply.^[17] Overall, while menu costs provide a microfoundation for price stickiness, adjustment frictions underscore causal mechanisms—rooted in verifiable transaction hurdles—driving persistent nominal deviations from flexible-price equilibria, with aggregate effects scaling through firm heterogeneity and shock propagation.^[18]

Historical Development

Early Keynesian Foundations (1930s–1970s)

In The General Theory of Employment, Interest, and Money published in 1936, John Maynard Keynes posited that nominal wages exhibit downward rigidity, as workers resist cuts in money wages even when unemployment rises, preventing the labor market from clearing and sustaining involuntary unemployment.^[19]^[20] This rigidity arises from psychological and institutional factors, including workers' focus on nominal rather than real wages and the disruption caused by frequent wage renegotiations, leading to real wages that remain elevated relative to marginal productivity during deflationary periods.^[21] Keynes argued that such stickiness explains why economies fail to self-adjust to full employment, as falling prices would otherwise erode real wages but are thwarted by nominal frictions.^[19] Keynes extended nominal rigidity to prices, asserting that in the short run, both wages and prices adjust sluggishly due to contractual arrangements and uncertainty, blocking the classical mechanism of flexible prices restoring equilibrium output.^[22] This framework underpinned early Keynesian models, such as John Hicks's 1937 IS-LM synthesis, which assumed fixed nominal prices in the short run to analyze how fiscal and monetary policies could influence aggregate demand and output.^[23] Empirical observations from the Great Depression, where U.S. nominal wages declined only modestly—by about 20% from 1929 to 1933 despite severe deflation—supported these ideas, as wage cuts were uneven and insufficient to restore full employment.^[24] Through the 1940s to 1970s, Keynesian macroeconomics formalized nominal rigidities as a core assumption, justifying countercyclical policies to offset demand shortfalls without relying on market clearing.^[22] Textbooks and policy frameworks, including the Phillips curve relating inflation to unemployment (A.W. Phillips, 1958), implicitly incorporated wage and price stickiness to explain trade-offs, influencing postwar economic management in Western economies where governments targeted full employment via demand stimulus.^[23] However, these models treated rigidities as ad hoc behavioral assumptions rather than microfounded frictions, a limitation later critiqued as empirical anomalies like 1970s stagflation emerged, challenging the stability of such rigidities under high inflation.^[25]

Rise of New Keynesian Economics (1980s–1990s)

The rise of New Keynesian economics in the 1980s addressed the new classical school's emphasis on rational expectations and the Lucas critique, which invalidated traditional Keynesian policy multipliers by assuming flexible prices rendered anticipated monetary actions neutral.^[26] New Keynesians retained Keynesian advocacy for countercyclical policy but grounded it in microfoundations featuring optimizing agents under monopolistic competition and nominal rigidities, enabling nominal disturbances to propagate into real output fluctuations. This framework explained empirical regularities like monetary non-neutrality during low-inflation periods, where price adjustments lagged despite rational agents.^[27] Central to this development were models of nominal price and wage stickiness derived from firm-level optimization. John B. Taylor's 1979 staggered wage contract model demonstrated how overlapping multi-period agreements, motivated by bargaining costs and information lags, generated persistent real effects from nominal shocks, with wages adjusting in discrete steps rather than continuously. Guillermo A. Calvo's 1983 staggered pricing mechanism extended this to prices, positing that only a fraction of firms optimally reset prices each period due to fixed adjustment costs, yielding a hybrid New Keynesian Phillips curve linking inflation to expected future inflation and output gaps. Gregory Mankiw's 1985 menu cost model further showed that even trivial fixed costs of price changes, under imperfect competition, could trigger large aggregate output responses via coordination failures and multiplier effects.^[28] By the 1990s, these microfounded rigidities were synthesized with real business cycle elements, forming dynamic stochastic general equilibrium models that dominated macroeconomic research.^[26] Olivier Blanchard and Nobuhiro Kiyotaki's 1987 analysis highlighted demand externalities amplifying small price rigidities into economy-wide disequilibria, while Laurence Ball and David Romer's 1990 work integrated real rigidities—like variable markups—to enhance nominal frictions' macroeconomic impact. Julio Rotemberg and Michael Woodford's quadratic adjustment cost approximations facilitated tractable DSGE simulations, influencing central bank practices by quantifying how nominal inertia shaped optimal interest rate rules amid rational expectations.^[29] This era's empirical support came from vector autoregressions confirming monetary shocks' delayed effects on prices relative to output, validating the paradigm's causal claims over pure flexibility assumptions.^[27]

Evolution in the 2000s and Beyond

In the early 2000s, nominal rigidity models evolved beyond traditional time-dependent pricing frameworks, such as the Calvo model, toward alternatives emphasizing information frictions. Mankiw and Reis (2002) proposed a sticky-information model where agents update prices based on outdated information clusters, generating persistent inflation responses to monetary shocks that better matched empirical Phillips curve dynamics than sticky-price alternatives.^[30] Concurrently, Sims (2003) introduced rational inattention, positing that firms and households optimally allocate limited cognitive resources to process economic signals, leading to infrequent price adjustments even without explicit menu costs.^[31] These approaches shifted focus from mechanical adjustment lags to endogenous information costs, enhancing microfoundations in New Keynesian frameworks.^[32] State-dependent pricing gained traction mid-decade, with Golosov and Lucas (2007) calibrating a menu-cost model using micro price data to argue that small, infrequent firm-level adjustments could amplify into substantial aggregate rigidity under strategic selection effects.^[33] However, critiques noted that such models struggled to replicate observed inflation persistence without additional real rigidities, prompting hybrid specifications combining time- and state-dependent elements.^[34] Empirical calibration increasingly drew from scanner and firm-level datasets, revealing average price durations of 8-11 months in the U.S., shorter than previously assumed, which necessitated refinements to parameterize rigidity frequencies.^[35] Following the 2008 financial crisis, attention turned to downward nominal wage rigidity (DNWR), as low inflation and near-zero interest rates heightened risks of real wage deflation constraints. Studies documented operative DNWR in U.S. data, with nominal cuts below 0% rare (occurring in under 2% of cases pre-crisis), constraining adjustment during the Great Recession and contributing to unemployment spikes.^[36] New Keynesian models incorporated nominal wage stickiness alongside prices, often via Calvo-style wage setting in search-friction labor markets, improving fits to post-crisis output and inflation paths.^[37] By the 2010s, Bayesian estimations favored nominal over real wage rigidities for capturing labor market dynamics, with wage durations estimated at 3-4 quarters.^[38] In the 2020s, high-inflation episodes tested rigidity assumptions, with evidence of accelerated price adjustments (durations shortening to 4-6 months in some sectors) yet persistent wage stickiness amid supply shocks.^[39] DSGE models evolved to include heterogeneous firm responses and financial amplifiers, maintaining nominal frictions as core to explaining disinflation without deep recessions, though debates persist on whether low pre-2021 inflation overstated DNWR's macroeconomic costs.^[40]^[41]

Types of Nominal Rigidities

Price Stickiness

Price stickiness refers to the observation that nominal prices of goods and services often fail to adjust rapidly or fully in response to shifts in supply, demand, or marginal costs, leading to persistent deviations from flexible-price equilibria. This phenomenon contributes to nominal rigidity by impeding the clearing of markets, particularly during economic fluctuations. Empirical studies consistently document that price changes occur infrequently relative to theoretical predictions under perfect flexibility, with the median duration of price spells exceeding one quarter in many sectors. For instance, analysis of U.S. Bureau of Labor Statistics data reveals that prices in the Consumer Price Index (CPI) change with a frequency of approximately 11% per month on average, implying an average duration of about 8-9 months.^[42] ^[43] Several microeconomic frictions explain price stickiness. Menu costs, the fixed expenses associated with altering prices—such as updating catalogs, reprogramming computers, or negotiating with suppliers—deter frequent adjustments, especially for small deviations from optimal pricing. Surveys of firm managers confirm that such costs, though modest in absolute terms (often under 1% of revenue), accumulate across large firms and amplify reluctance to repricing. Additional factors include long-term contracts that lock in prices, customer search costs that reward stability to avoid eroding loyalty, and strategic complementarities where firms hesitate to cut prices unilaterally if competitors do not follow suit. These mechanisms operate more prominently for small cost shocks, where the benefits of adjustment fall below adjustment frictions, resulting in state-dependent pricing behavior.^[44] ^[45] Micro-level evidence from detailed price datasets underscores the prevalence of stickiness across industries. In a comprehensive study of 350 CPI categories covering 70% of U.S. consumer expenditures, prices changed with a median frequency such that half lasted less than 4.3 months, though durable goods and services exhibited longer spells (up to 10-12 months). Sectoral variations persist: raw commodities adjust more often (frequencies exceeding 20% monthly) than processed goods or services (under 10%), reflecting differences in competition and contract intensity. Macro evidence aligns, as sticky-price components of core CPI—excluding volatile food and energy—have shown slower mean reversion during disinflation episodes compared to flexible-price aggregates.^[46] ^[43] ^[42] Recent high-inflation periods, including the 2021-2023 surge, highlight conditional flexibility: overall price change frequencies rose to 15-20% monthly in some datasets as inflation exceeded 7% annually, driven by energy and supply shocks, yet core sticky prices (e.g., housing rents, professional services) decelerated more gradually, sustaining inflation persistence into 2023-2024. Post-pandemic analysis indicates a modest increase in adjustment speed for certain categories, with year-on-year CPI changes reflecting reduced backlogs, but stickiness in services remained elevated due to wage pass-through and capacity constraints. These patterns affirm that while extreme shocks erode stickiness, baseline frictions ensure incomplete passthrough, with implications for monetary policy transmission.^[47] ^[48] ^[49]

Wage Stickiness and Downward Rigidity

Wage stickiness denotes the tendency for nominal wages to adjust infrequently or slowly in response to shifts in labor market conditions, contributing to nominal rigidities in macroeconomic models. Downward nominal wage rigidity (DNWR), a prominent manifestation, refers to the asymmetric resistance against nominal wage reductions, where cuts are rarer than increases even amid excess labor supply or recessions. This phenomenon implies that real wages may decline via inflation rather than direct nominal cuts, preserving worker purchasing power perceptions but potentially exacerbating unemployment as firms opt for layoffs or reduced hiring instead. Empirical analyses using micro-level data consistently document DNWR, with nominal wage cuts occurring in fewer than 2% of cases for job stayers in the United States, far below levels predicted by frictionless adjustment models.^[19]^[50] Theoretical rationales for DNWR draw from behavioral and contractual frictions rather than pure market clearing. Efficiency wage models posit that firms maintain premiums above market-clearing levels to incentivize effort, deter shirking, and minimize turnover costs, rendering cuts counterproductive as they erode morale and productivity. Implicit long-term contracts and insider-outsider dynamics further entrench rigidity, where incumbent workers' bargaining power shields them from reductions, shifting adjustment burdens to new hires or employment levels. Survey-based evidence from managerial interviews reinforces these mechanisms, revealing widespread aversion to cuts due to anticipated resentment, sabotage, or quitting, with executives reporting that even small reductions trigger disproportionate effort withdrawals. One study interviewing over 300 firms during the 1990s recession found no instances of broad wage slashing, attributing persistence to fairness norms and reference-dependent utility.^[51] Empirical quantification of DNWR employs longitudinal datasets like the U.S. Panel Study of Income Dynamics (PSID) and employer payroll records, revealing bunching of wage changes at zero and positive thresholds. For instance, pre-2008 data indicate that 50-60% of workers experienced no nominal wage change year-over-year, with cuts comprising under 1% versus 10-15% increases, implying a "spike" at zero that intensifies during low-inflation periods. During the Great Recession (2007-2009), despite unemployment peaking at 10%, the incidence of wage cuts rose modestly to 2-3% but remained suppressed relative to macroeconomic shocks, with rigidity bending the wage Phillips curve and amplifying output losses by 1-2% annually in simulations. Cross-country evidence from the International Wage Flexibility Project corroborates asymmetry, showing DNWR strongest in low-inflation advanced economies, where zero-cut fractions exceed 90% in some cohorts. Central bank analyses, including Federal Reserve studies, estimate that DNWR accounts for 20-30% of unemployment persistence in recessions, as firms hoard labor inefficiently rather than renegotiate pay.^[36]^[50]^[52]^[53] In high-inflation episodes, such as the U.S. surge from 2021-2023, DNWR softened somewhat, with nominal cuts reaching 5-7% in tight labor markets, yet asymmetry endured as reductions lagged demand-driven hikes. This adaptability underscores DNWR's sensitivity to inflation expectations, where positive price changes facilitate real wage erosion without nominal confrontation, aligning with causal evidence from disinflation experiments in the 1980s where anticipated cuts met resistance absent price cover. Overall, while microdata affirm DNWR's prevalence, debates persist on its macroeconomic amplification, with some calibrations suggesting modest effects absent complementary frictions like search costs.^[54]^[39]

Sticky Information and Rational Inattention

The sticky information model, proposed by N. Gregory Mankiw and Ricardo Reis in 2001, posits that nominal rigidities arise because economic agents update their information sets infrequently rather than because prices themselves are fixed.^[30] In this framework, price setters and wage negotiators form optimal plans based on a weighted average of current and past expectations, with a fraction λ updating fully each period while others retain outdated information.^[55] This leads to prices that adjust every period but incorporate stale data on aggregate shocks, such as monetary policy changes, resulting in persistent deviations from flexible-price equilibria even after shocks dissipate.^[56] Unlike menu cost models, where adjustment frictions prevent price changes, sticky information generates inflation dynamics with prolonged effects from past expectations, aligning with observed macroeconomic inertia without requiring state-dependent costs.^[57] Empirical evaluations of the sticky information model, often compared to Calvo-style sticky price models, show mixed results; for instance, Bayesian estimations using U.S. data from 1954–2005 indicate that sticky information better captures the persistence of inflation responses to output gaps in some specifications, though it underperforms in matching the hump-shaped impulse responses typical of vector autoregressions.^[58] Extensions incorporate general equilibrium settings, where households and firms optimize under sticky information, amplifying the real effects of nominal shocks through lagged expectational terms in Euler equations and Phillips curves.^[59] Critics note that the model's assumption of uniform update probabilities across agents lacks direct microevidence, and it predicts frequent small price changes inconsistent with sector-level data showing infrequent adjustments.^[60] Rational inattention, formalized by Christopher Sims in 2003, provides an alternative microfoundation for nominal rigidities by modeling agents' limited information-processing capacity as a constraint on entropy reduction, akin to Shannon's information theory.^[31] Agents optimally allocate scarce attention to signals that maximize utility, leading to gradual incorporation of news into decisions; for prices, this implies sluggish adjustments to cost or demand shocks as firms partially ignore low-signal-to-noise variables.^[32] In monetary models, rational inattention generates inertia in aggregate variables without fixed update intervals, as attention costs rise with the flow of surprising information, endogenously varying with economic volatility. Unlike sticky information's discrete, probabilistic updates, rational inattention allows continuous but costly processing, often producing noisy private signals and heterogeneous responses across agents based on perceived signal precision.^[61] Applications to pricing show firms setting prices farther from optimal levels during high-uncertainty periods, enhancing monetary non-neutrality; for example, simulations indicate that inattentive firms amplify output responses to interest rate shocks by 20–50% relative to full-information benchmarks.^[62] Empirical support includes sector analyses where sticky-price sectors exhibit stronger rigidity than predicted by pure inattention models, suggesting complementarities with menu costs, though inattention better explains forecast errors in surveys.^[63] Both models underscore cognitive frictions over physical costs, but rational inattention's flexibility in attention allocation aligns more closely with behavioral evidence of selective focus amid abundant data.^[64]

Empirical Evidence

Microeconomic Studies and Firm-Level Data

Microeconomic analyses of disaggregated price data from sources such as the U.S. Bureau of Labor Statistics (BLS) Consumer Price Index (CPI) have established that individual prices adjust infrequently, with median durations of unchanged prices ranging from 8 to 11 months in U.S. data spanning 1988 to 2005.^[1] Klenow and Kryvtsov (2008), examining BLS microdata, distinguished between regular price adjustments and temporary sales, finding that non-sale prices persist for a median of 11 months, while overall price spells average shorter durations due to sales activity that masks underlying rigidity.^[1] Similarly, Nakamura and Steinsson (2008) reported a monthly price change frequency of approximately 9.8% in the same dataset, implying an average duration of about 10 months, with greater stickiness in services (durations exceeding 12 months) compared to goods.^[1] Firm-level evidence reinforces these patterns, showing that adjustment frictions, including menu costs, contribute to infrequent repricing. Surveys of European manufacturing firms indicate that explicit menu costs—such as reprinting catalogs or updating software—represent a small fraction of revenues (often less than 0.1%), but implicit costs like managerial time and customer dissatisfaction amplify the effective barrier, leading firms to tolerate deviations from optimal pricing for extended periods.^[65] In U.S. retail settings, direct observation of supermarket pricing reveals that managerial coordination and customer search costs outweigh physical menu costs, with firms changing prices only when cumulative cost deviations exceed thresholds equivalent to 10-20% of monthly sales.^[65] Cross-sectoral firm data further highlight heterogeneity: small firms exhibit higher rigidity due to proportionally larger fixed adjustment costs per unit output, while large firms adjust more readily but still infrequently outside high-inflation episodes.^[66] These micro-level findings align with broader patterns in business surveys, where managers cite strategic considerations—such as preserving customer relationships—and coordination frictions as primary deterrents to price changes, rather than demand insensitivity alone. For example, in Fifth District surveys, over 60% of firms reported delaying price hikes despite rising input costs, attributing delays to anticipated customer resistance and internal decision lags.^[67] Empirical pass-through estimates from firm-level cost and price data average around 60%, indicating partial adjustment even to verifiable cost shocks, consistent with nominal frictions amplifying real effects.^[68] Such evidence from granular data underscores that nominal rigidity arises not from irrationality but from rational responses to adjustment costs in decentralized markets.

Macroeconomic Correlations and Business Cycle Patterns

Macroeconomic analyses reveal that nominal rigidities amplify business cycle fluctuations by impeding rapid adjustments in prices and wages to demand shocks, leading to persistent output gaps and asymmetric responses between expansions and recessions. In particular, downward nominal wage rigidities prevent significant wage reductions during downturns, resulting in higher unemployment persistence and deeper recessions compared to the expansions that follow. Empirical evidence from U.S. historical time series and cross-sectional state-level data confirms that such rigidities account for a notable portion of aggregate fluctuations, with wage distributions showing bunching at zero changes during low-inflation periods.^[69] ^[52] Price rigidities exhibit countercyclical patterns, with frequency of price adjustments declining during recessions, which correlates with slower disinflation and amplified real effects of monetary policy. A structurally estimated series of U.S. aggregate price rigidities from 1978 to 2023 demonstrates that rigidity measures rise amid output contractions, contributing to the propagation of shocks through reduced price flexibility.^[70] This pattern aligns with "plucking" models of business cycles, where wage and price stickiness is more pronounced in downturns, fostering deviations from full employment that resolve more gradually in recoveries.^[71] Inflation dynamics further underscore these correlations, as nominal rigidities link output gaps to lagged inflation responses via mechanisms like the New Keynesian Phillips curve, where sticky prices sustain inflationary pressures or deflationary risks unevenly across cycles. Studies of persistent large output gaps in advanced economies show that rigidities moderate inflation pass-through during expansions but exacerbate output losses in recessions, with downward wage constraints bending the short-run Phillips curve at low inflation thresholds.^[72]^[73] Overall, these patterns indicate that nominal frictions heighten cycle volatility, with empirical models incorporating firm-specific capital and rigidities explaining up to substantial fractions of observed U.S. output variance.^[74]

Evidence from High-Inflation Periods and the 2020s

Studies of the U.S. Great Inflation period (roughly 1965–1982), when annual CPI inflation averaged over 7%, reveal that the frequency of retail price changes rose significantly compared to prior low-inflation decades, with the incidence of price adjustments increasing by approximately 50% in some consumer goods categories, while the average size of changes remained modest. This pattern suggests that elevated inflation reduced nominal price stickiness by incentivizing firms to update prices more often to avoid accumulating real price distortions, consistent with menu cost models where the opportunity cost of inaction grows with inflation.^[75] Similar dynamics appeared in earlier high-inflation episodes; for instance, analysis of newsstand prices from 1953–1979 showed that inflation rates above 5% correlated with adjustment frequencies doubling relative to stable-price periods, underscoring a state-dependent response rather than fixed-duration rigidity.^[76] These findings align with broader empirical patterns across hyperinflation cases, where price adjustment frequencies can reach daily levels, as the nominal drift from sticky pricing becomes unsustainable amid rapid monetary expansion. In such environments, the dispersion of relative prices temporarily widens due to heterogeneous adjustment speeds but narrows as most firms accelerate changes, providing evidence that nominal rigidities are not absolute but erode under high inflationary pressure. This contrasts with low-inflation regimes, where average price durations extend to 8–12 months, supporting the causal role of nominal frictions in amplifying aggregate price level persistence during business cycles.^[77] In the 2020s, particularly during the post-pandemic inflation surge (2021–2023), when U.S. CPI inflation peaked at 9.1% in June 2022, scanner data from retail outlets documented a sharp rise in price change frequency—from about 10% monthly pre-pandemic to over 15% by mid-2022—mirroring historical high-inflation responses and marking the first such U.S. confirmation in large-scale microdata. Euro area firm surveys similarly reported state-dependent price-setters increasing adjustment rates from 11% to 25% as own-price inflation expectations climbed to 8%, while time-dependent setters showed milder increases, indicating that high inflation triggers opportunistic repricing beyond rigid schedules. For wages, nominal adjustments in the U.S. from 2020–2023 averaged 4.8% annually against 4.5% CPI growth, with tighter labor markets facilitating catch-up but evidence of bunching and downward rigidity persisting, as firms resisted cuts despite cooling demand pressures.^[47]^[78]^[54] Overall, these observations reinforce that nominal rigidities diminish in magnitude during inflationary episodes, allowing faster real price equilibration but highlighting their relevance in explaining delayed disinflation post-peak.^[79]

Theoretical Modeling

State-Dependent vs. Time-Dependent Pricing Models

In time-dependent pricing models, firms adjust prices according to a schedule that is independent of current economic conditions, such as a constant probability of price review each period regardless of shocks to costs or demand.^[80] The canonical example is the Calvo (1983) framework, where each firm faces a fixed probability \lambda (typically calibrated around 0.25 quarterly) of optimally resetting its price in any given period, while non-adjusting firms carry forward previous prices, leading to staggered adjustments across the economy.^[81] This setup generates aggregate price rigidity through selection effects, where recently adjusted prices are more responsive to shocks, but the overall frequency of changes remains invariant to the state.^[82] State-dependent pricing models, in contrast, posit that firms change prices only when the benefits of adjustment—driven by deviations between current optimal prices and existing ones—exceed fixed menu costs or other frictions, making the decision contingent on aggregate and idiosyncratic state variables like marginal costs.^[83] Originating from menu cost theories such as Sheshinski and Weiss (1977) and extended in Golosov and Lucas (2007), these models feature firms optimally timing adjustments, resulting in infrequent changes during low-variance states but clustered adjustments during large shocks, as high deviations trigger widespread repricing.^[84] Unlike time-dependent approaches, state dependence allows for endogenous selection, where firms farther from optimal prices are more likely to adjust, amplifying the responsiveness of the aggregate price level to macroeconomic disturbances.^[85] The core distinction lies in the responsiveness of price adjustment frequency and magnitude to economic states: time-dependent models predict constant adjustment hazard rates and symmetric responses, yielding persistent real effects from nominal shocks due to mechanical staggering, whereas state-dependent models produce countercyclical frequency (more changes in booms or high-inflation episodes) and procyclical magnitude, with aggregate prices adjusting faster as shocks synchronize firm incentives.^[80]^[86] For instance, in state-dependent setups, a positive aggregate demand shock raises adjustment probabilities economy-wide, mitigating monetary non-neutrality more rapidly than in Calvo-style models, where only a fixed fraction adjusts irrespective of the shock size.^[87] This difference arises because time dependence imposes exogenous timing, often overestimating rigidity in micro-founded simulations compared to state dependence, which better captures strategic firm behavior but requires solving high-dimensional fixed-point problems.^[88] Macroeconomic implications diverge notably in monetary policy transmission and business cycle dynamics. Time-dependent models, favored in tractable New Keynesian DSGE frameworks, imply longer-lived output responses to interest rate changes—e.g., a 1% monetary shock persisting for 8-12 quarters—due to the inertia from non-adjusters dominating aggregate dynamics.^[85] State-dependent models, however, exhibit shorter persistence (often halved) and asymmetry, with expansionary shocks propagating more strongly than contractionary ones, as menu costs dampen small deviations but amplify large ones through granular firm heterogeneity. Empirical tests using micro price data, such as U.S. CPI records from 1988-2016, find mixed support: time dependence explains baseline inflation persistence better in low-volatility periods, while state dependence fits hazard rates during high-inflation events like the 2021-2023 U.S. surge, where adjustment frequencies rose with cost-push shocks, though menu costs alone underpredict the scale of price hikes.^[83]^[89] Recent calibrations suggest hybrid approaches, combining both mechanisms, may reconcile micro moments like S-shaped hazard functions with macro inertia.^[90]^[91]

Integration with New Keynesian Frameworks

New Keynesian models integrate nominal rigidities by embedding microfounded frictions into dynamic stochastic general equilibrium (DSGE) frameworks with rational expectations and monopolistic competition, thereby generating sluggish aggregate price adjustment and real effects from nominal disturbances.^[27] This contrasts with New Classical models, where flexible prices imply neutrality of money, as rigidities create a wedge between marginal cost and price, allowing monetary policy to influence output and employment in the short run.^[92] The integration preserves optimizing behavior at the firm and household level while justifying deviations from market clearing, with nominal rigidities calibrated to match empirical duration of price spells, often around 8-12 months in advanced economies.^[93] A foundational approach is the Calvo (1983) timing mechanism, under which each firm independently faces a constant probability $1 - \theta of resetting its price each period, while non-adjusting firms maintain prior prices; \theta represents the survival probability of unchanged prices, implying an average price duration of $1/(1 - \theta) quarters.^[94] This time-dependent rule aggregates to a New Keynesian Phillips curve (NKPC) relating current inflation to expected future inflation and the output gap: \pi_t = \beta E_t \pi_{t+1} + \kappa y_t, where \beta is the discount factor, \kappa captures the slope from marginal cost pass-through, and y_t is the output gap.^[94] The parameter \theta directly influences \kappa, with higher rigidity (larger \theta) flattening the curve and amplifying policy transmission.^[93] Complementing Calvo pricing, Taylor's (1980) staggered contract model assumes firms set prices for a fixed horizon of N periods in overlapping cohorts, with one Nth of firms adjusting each period; for quarterly N=4, this yields two-quarter-ahead forward-looking inflation dynamics.^[92] This structure produces a hybrid NKPC with both forward and backward inflation terms, \pi_t = \lambda_b \pi_{t-1} + (1 - \lambda_b) E_t \pi_{t+1} + \kappa y_t, where \lambda_b depends on N and increases persistence.^[92] Empirical calibrations often favor Taylor over pure Calvo for capturing observed inflation inertia, though both are critiqued for lacking state-dependence.^[94] In broader DSGE integration, nominal rigidities interact with real frictions like habit formation or variable capital utilization, enhancing model fit to business cycle data; for instance, wage rigidities alongside price stickiness amplify labor market responses to shocks.^[95] These elements underpin quantitative analyses of optimal policy, such as Taylor rules stabilizing deviations from the natural rate, with rigidities justifying positive inflation targets to grease relative price adjustments.^[92] Estimated DSGE models, incorporating Calvo or Taylor frictions, replicate U.S. inflation-output trade-offs post-1980s, though parameter stability remains debated amid low-inflation regimes.^[93]

Mathematical Illustrations of Amplification Effects

In static models of partial price rigidity, amplification effects arise because a subset of prices remains fixed, flattening the aggregate supply curve and permitting larger real output responses to nominal demand shocks. Consider a simplified log-linear economy where aggregate demand is given by y = m - p, with y denoting log output, m log money supply, and p log price level (assuming unit interest semi-elasticity for simplicity). Flexible-price firms set prices equal to marginal cost, normalized such that p_{\text{flex}} = y (zero markup, constant returns for illustration). A fraction \theta of firms cannot adjust and retain prior prices p_f = 0 (initial equilibrium), while the remaining $1 - \theta set p_{\text{flex}} = y. The aggregate price level approximates p = \theta p_f + (1 - \theta) p_{\text{flex}} = (1 - \theta) y. Substituting into demand yields y = \Delta m - (1 - \theta) y, so y [1 + (1 - \theta)] = \Delta m, or y = \frac{\Delta m}{2 - \theta}.^[96]^[97] In the full flexible-price case (\theta = 0), y = \frac{\Delta m}{2}, as prices fully adjust to offset the nominal shock via p = y = \frac{\Delta m}{2}. With rigidity (\theta > 0), the output response exceeds this benchmark, as \frac{1}{2 - \theta} > \frac{1}{2}; for example, at \theta = 0.75 (prices fixed three-quarters of the time), y = \frac{\Delta m}{1.25} = 0.8 \Delta m, amplifying the real effect by a factor of 1.6 relative to flexibility. This occurs because the incomplete aggregate price response (\Delta p = (1 - \theta) y < \Delta m) sustains higher real balances, boosting demand and output beyond the flexible equilibrium. The mechanism scales with \theta: as \theta \to 1, the supply curve flattens asymptotically, implying unbounded amplification in this linear-cost setup, though realistic convex costs would cap it.^[96]^[90] Dynamic extensions, such as the Calvo (1983) model integrated into New Keynesian frameworks, preserve and generalize this amplification. Firms reset prices with fixed probability $1 - \theta each period, leading to a downward-sloping New Keynesian Phillips curve \pi_t = \beta E_t \pi_{t+1} + \lambda \tilde{y}_t, where \pi_t is inflation, \tilde{y}_t is the output gap, \beta < 1 is the discount factor, and \lambda = \frac{(1 - \theta)(1 - \beta \theta)}{\theta} \cdot \frac{1 + \phi}{1 + \phi \eta} (with \phi the marginal cost slope and \eta elasticity). Higher \theta reduces \lambda, flattening the curve and magnifying output-gap responses to monetary shocks in the combined IS-Phillips system.^[98]^[99] Impulse response analyses show that a 1% innovation in the nominal interest rate (proxying monetary tightening) elicits an output contraction roughly proportional to $1/\lambda; calibrations with \theta \approx 0.75 (average price duration of one year) yield peak responses 2-3 times larger than in flexible-price benchmarks.^[100]^[91] Heterogeneity across sectors or firms further intensifies amplification, as state-dependent adjustments (e.g., via menu costs) interact with time-dependent rigidity to propagate shocks unevenly. In multi-sector Calvo variants, cross-sectoral dispersion in \theta can double the aggregate output effect of monetary shocks relative to homogeneous models, as fixed-price sectors constrain overall price flexibility while flexible ones partially accommodate.^[91]^[99] These illustrations underscore how nominal rigidities transform neutral nominal disturbances into potent real fluctuations, a core rationale for their inclusion in macroeconomic modeling despite micro-level variability in adjustment frequencies.^[96]

Criticisms and Debates

Challenges to Microfoundations and Behavioral Realism

Microeconomic evidence from detailed price data challenges the microfoundations of nominal rigidity models, as firm-level prices adjust more frequently than required to generate the observed macroeconomic persistence of inflation and output responses to nominal shocks. Analysis of U.S. Bureau of Labor Statistics data for approximately 70% of consumer spending reveals that the median duration of price spells is around 5.7 months, with prices changing substantially in 86% of non-housing categories more often than for the stickiest goods like magazines.^[46] This frequency implies limited individual-level rigidity, yet New Keynesian models, particularly time-dependent ones like Calvo pricing, must calibrate adjustment probabilities to imply durations of 12-24 months or longer to match aggregate dynamics, rendering the aggregation from micro to macro implausible without additional unverified assumptions.^[96] Theoretical microfoundations such as menu costs face similar scrutiny, as standard state-dependent models struggle to reconcile frequent small price changes at the micro level with infrequent large adjustments needed for business cycle amplification. Quantitative evaluations indicate that nominal frictions alone produce insufficient persistent real effects from monetary shocks, necessitating supplementary real rigidities like countercyclical markups, which undermine claims of purely nominal origins for aggregate stickiness.^[6] The Calvo framework, assuming random reoptimization timing independent of economic conditions, further deviates from empirical patterns where price adjustments exhibit state dependence, such as increased frequency during high-inflation episodes, highlighting a disconnect between optimizing firm behavior and observed heterogeneity in adjustment hazards.^[101] These models' reliance on fully rational, optimizing agents lacks behavioral realism, as evidence points to non-optimizing factors like fairness perceptions and morale effects driving nominal wage rigidity, which standard frameworks overlook in favor of mechanical costs or contracts. Downward nominal wage cuts provoke efficiency wage losses from perceived unfairness, a phenomenon rooted in psychological reference points rather than profit-maximizing calculations under symmetric adjustment frictions, yet incorporated only peripherally in core New Keynesian setups.^[102] This omission persists despite behavioral insights revealing that agents deviate from hyper-rationality through heuristics and loss aversion, better explaining persistent rigidities without invoking implausibly calibrated optimization parameters, thus questioning the causal fidelity of rational microfoundations to real-world decision-making under uncertainty.^[103]

Alternative Explanations from Non-Keynesian Schools

Real business cycle (RBC) theory explains macroeconomic fluctuations through exogenous real shocks, primarily to total factor productivity, in models featuring flexible prices and wages that clear markets continuously. Developed by Kydland and Prescott in 1982, these dynamic general equilibrium frameworks assume rational agents optimize consumption, labor supply, and investment decisions intertemporally, generating business cycle properties—such as output volatility, procyclical hours worked, and investment swings—without invoking nominal rigidities as a propagation mechanism.^[104] Technology shocks are estimated to account for over 50% of postwar U.S. output variance, with calibration to microeconomic data showing efficient responses to supply-side disturbances rather than demand-side frictions or monetary non-neutrality.^[104] Austrian business cycle theory attributes booms and busts to central bank-induced credit expansion that lowers interest rates below their natural equilibrium level, distorting relative prices and prompting unsustainable investments in longer-term production processes (malinvestments).^[105] The subsequent bust corrects these intertemporal discoordinations through resource reallocation, with price signals—assumed to be relatively flexible—facilitating adjustment despite informational challenges in complex economies; nominal rigidities play no central causal role, as cycles stem from policy-driven capital structure imbalances rather than wage or price stickiness.^[105] New classical economics, building on rational expectations propositions from Lucas (1972), critiques reliance on nominal rigidities by positing that markets clear even in the short run, with only unanticipated shocks—real or monetary—generating temporary deviations from full employment. Systematic policy lacks real effects due to agents' forward-looking behavior, rendering nominal frictions unnecessary for explaining cycles, which instead arise from unpredictable disturbances in a flexible-price equilibrium.^[106] Monetarist explanations, as articulated by Friedman and Schwartz (1963), trace business cycles to irregular changes in money supply growth, which influence nominal spending and induce lags in relative price adjustments, but emphasize long-run monetary neutrality where prices ultimately flex to restore equilibrium without persistent real distortions from rigidities.^[107] Velocity instability and policy errors amplify these monetary impulses, yet the core mechanism operates through quantity theory dynamics assuming sufficient price responsiveness over time, downplaying nominal stickiness as the primary driver of output persistence.^[108]

Empirical Disputes on Magnitude and Causality

Empirical studies using micro-level price data have challenged the assumed magnitude of nominal price rigidity in macroeconomic models. Bils and Klenow (2004) analyzed U.S. Bureau of Labor Statistics data for 350 categories covering 70% of consumer spending from 1995–1997, finding that the median price duration was 4.3 months overall and 5.5 months excluding temporary sales, implying more frequent adjustments than the 8–12 months often calibrated in New Keynesian models with Calvo-style pricing.^[43]^[109] This evidence suggests that nominal rigidities may contribute less to aggregate price inertia than previously estimated, as large price changes during infrequent adjustments account for much of observed inflation dynamics, potentially overstating the role of menu costs in standard frameworks. Klenow and Kryvtsov (2008) extended this analysis to 1988–2003 CPI microdata, confirming shorter durations and highlighting that durable goods exhibit greater flexibility, further questioning the universality and persistence of stickiness across sectors.^[110] Disputes persist regarding whether these micro findings scale to macroeconomic amplification of shocks. Critics argue that while individual prices adjust relatively often, strategic complementarities or state-dependent factors could sustain rigidity at the aggregate level, but empirical tests show mixed results; for instance, Gorodnichenko and Weber (2016) found no significant stock market penalty for firms with stickier prices, implying limited real costs to rigidity and thus questioning its causal potency in driving output volatility.^[15] In contrast, Alvarez et al. (2016) reconciled micro flexibility with macro persistence by emphasizing large but infrequent changes, yet this interpretation remains contested as it relies on assumptions about markup variability rather than direct evidence of rigidity's independent effects. Recent post-pandemic analyses of CPI data indicate heightened price flexibility during the 2021–2023 inflation surge, with faster pass-through of costs to consumers, suggesting that nominal rigidities weaken under high-inflation regimes and may not robustly explain disinflation delays or cycle asymmetries.^[47] On causality, structural vector autoregressions and business cycle decompositions reveal debates over whether nominal rigidities primarily cause or merely correlate with fluctuations. Altig et al. (2011) estimated that monetary shocks explain only a fraction of U.S. output variance in models incorporating sticky prices, with real shocks dominating, implying rigidities amplify but do not originate cycles.^[74] Real business cycle proponents, such as Chari et al. (2009), critique New Keynesian reliance on nominal frictions as ad hoc, arguing that observed stickiness lacks microfoundations sufficient to overturn evidence that productivity and supply shocks drive most variance without invoking price/wage sluggishness.^[111] Empirical Granger causality tests in hybrid models often fail to establish unidirectional influence from rigidity measures to output gaps, with bidirectional feedbacks or omitted real rigidities (e.g., habit formation) confounding attribution; for example, Durante and Trabandt (2024) document time-varying U.S. price rigidities from 1978–2023 but find their explanatory power for cycles diminishes post-2008, favoring financial and supply-side causal channels.^[70] These disputes underscore that while nominal rigidities correlate with non-neutral monetary transmission, causal claims require isolating them from confounding real and informational frictions, a challenge unmet in many calibrations.^[112]

Macroeconomic Implications and Policy Relevance

Role in Business Cycles and Recessions

Nominal rigidities contribute to business cycle fluctuations by impeding the rapid adjustment of prices and wages to economic shocks, thereby translating nominal disturbances into persistent real effects on output and employment. In standard New Keynesian frameworks, sticky prices prevent firms from optimally responding to aggregate demand changes, leading to quantity adjustments—such as reduced production and hiring—instead of price declines during downturns. This amplification mechanism accounts for a significant portion of observed output volatility, as monetary policy shocks propagate through the economy via these frictions, generating comovements in macroeconomic aggregates consistent with historical data.^[74] Similarly, nominal wage rigidities distort labor market clearing, where firms respond to negative shocks by cutting hours or laying off workers rather than lowering pay, heightening cyclical sensitivity.^[113] Empirical estimates of nominal price rigidities in the United States from 1978 to 2023 reveal time-varying degrees of stickiness, with rigidity peaking in the mid-1990s and mid-2010s, periods associated with greater vulnerability to demand contractions and slower recoveries.^[70] These fluctuations underscore how endogenous changes in pricing frictions can intensify business cycle dynamics, challenging models assuming constant rigidity and highlighting the role of sector-specific factors in modulating aggregate responses. For wages, microdata show that the frequency of nominal cuts remains low even amid slack, with rigidity constraining adjustment during expansions and contractions alike, though its effects are more pronounced in amplifying downturns.^[52] In recessions, downward nominal wage rigidities (DNWR) particularly deepen contractions by limiting real wage flexibility, fostering unemployment spikes as employers hoard labor less effectively and output falls short of potential. Quantitative assessments indicate that DNWR imposes measurable losses, with simulations showing output reductions of several percentage points in low-inflation environments due to impeded wage deflation and resultant hiring frictions. During the Great Recession (2007–2009), U.S. wage data evidenced persistent rigidity, where nominal wage growth decelerated but cuts were infrequent—occurring in under 2% of jobs annually—contributing to unemployment peaking at 10% and prolonging the recovery through pent-up deflationary pressures.^[36] This asymmetry aligns with "plucking" models of cycles, where rigidities permit expansions to approach potential but prevent symmetric contractions, explaining deeper recessions relative to booms observed in postwar U.S. data since 1948.^[71]

Effects on Monetary Policy Transmission

Nominal rigidities enhance the effectiveness of monetary policy transmission by creating a lag in price adjustments, which allows nominal interest rate changes to temporarily alter real interest rates and thereby influence aggregate demand. In the absence of such rigidities, as in classical flexible-price models, monetary policy shocks primarily affect nominal variables without sustained real effects due to immediate price equilibration. With sticky prices, however, an expansionary policy shock—such as a cut in the short-term nominal interest rate—reduces real rates because aggregate prices rise more slowly than money supply, boosting output and employment through increased spending on durable goods and investment.^[114]^[115] In New Keynesian frameworks, the degree of nominal rigidity, often modeled via Calvo pricing where firms reoptimize prices randomly with probability $1 - \theta (implying an average price duration of $1/(1 - \theta) periods), amplifies these transmission channels. Lower adjustment frequencies (\theta closer to 1) flatten the short-run aggregate supply curve, leading to larger output responses and more persistent inflation dynamics following policy innovations, as shown in impulse response functions where real GDP peaks higher and decays more gradually compared to flexible-price benchmarks. Empirical estimates from vector autoregressions incorporating moderate rigidities replicate observed inflation inertia and output persistence after U.S. monetary shocks, with rigidities explaining up to 70% of the hump-shaped output response.^[116]^[117] Sectoral evidence further underscores this mechanism: industries with stickier prices, such as services, display amplified real output fluctuations to policy shocks relative to flexible-price sectors like traded goods, consistent with disaggregated impulse responses from Eurozone data where sticky-price sectors contribute disproportionately to aggregate transmission. This heterogeneity implies that aggregate policy efficacy depends on the economy-wide prevalence of rigidities, with micro-level menu costs or state-dependent factors reinforcing downward rigidity in prices during contractions, potentially exacerbating deflation risks if policy response is delayed.^[118]^[119]

Debates on Optimal Inflation Targets and Grease Effects

The concept of grease effects posits that moderate positive inflation facilitates relative price and wage adjustments in economies characterized by nominal rigidities, particularly downward rigidity in nominal wages, by allowing real declines without explicit nominal cuts that may be resisted due to psychological, contractual, or institutional factors.^[120] This mechanism, first prominently articulated by James Tobin in 1972 and elaborated in models incorporating menu costs and rigidity thresholds, suggests that inflation "greases the wheels" of labor and product markets by eroding real wages over time when nominal adjustments are infrequent or asymmetric.^[121] Empirical evidence from payroll data indicates that downward nominal wage rigidity is prevalent, with firms often compressing wage growth rather than imposing cuts during low-inflation periods, supporting the grease hypothesis as a rationale for avoiding zero inflation targets.^[39] Debates on optimal inflation targets center on balancing these grease benefits against inflation's costs, such as increased uncertainty, relative price variability (sand effects), and measurement biases in consumer price indices. Proponents of targets above zero, drawing from New Keynesian frameworks with downward nominal wage rigidity (DNWR), argue that the welfare gains from smoother adjustments outweigh shoe-leather costs at low positive rates; counterfactual simulations estimate that a 1% increase in inflation reduces the share of workers facing binding downward rigidities by approximately 0.8-1%, potentially justifying targets around 2% as adopted by major central banks like the Federal Reserve since 2012.^[122] ^[123] However, quantitative models yield varying optima, with some heterogeneous-agent frameworks estimating rates as high as 8.8% under strong DNWR assumptions, though such extremes are critiqued for overstating rigidity prevalence and underweighting inflation's distortionary impacts on long-term contracts and investment.^[124] ^[125] Critics, including monetarist and rational expectations scholars, contend that grease effects are overstated relative to sand effects, where inflation exacerbates nominal distortions and erodes monetary policy credibility; micro-level studies reveal that while DNWR exists, its macroeconomic influence diminishes at aggregate levels due to offsetting adjustments in employment and hours, questioning the necessity of persistent positive targets.^[126] Central banks' adherence to 2% reflects a precautionary buffer against the zero lower bound on nominal interest rates alongside grease considerations, but post-2008 debates—intensified by secular stagnation—have seen proposals to raise targets to 3-4% for enhanced adjustment flexibility, countered by evidence that higher inflation amplifies volatility without proportional gains in output stability.^[127] ^[128] Empirical disputes persist on causality, with firm-level data showing wage compression but limited aggregate evidence linking low inflation directly to prolonged recessions beyond other frictions like financial constraints.^[52] Overall, while grease effects provide a theoretically grounded case for positive inflation, rigorous calibration against microdata underscores that optimal targets likely remain modest, prioritizing stability over exaggerated adjustment benefits.

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In Mankiw and Reis (2002) we proposed a new way to model sluggish macroeconomic adjustment. In this paper we have explored how this approach can be used in ...
[60]
[PDF] STICKY INFORMATION IN GENERAL EQUILIBRIUM - LSE
In Mankiw and Reis (2002), we proposed a new way to model sluggish macro- economic adjustment. In this paper we have explored how this approach can be used in ...
[61]
Rigid pricing and rationally inattentive consumer - ScienceDirect.com
This paper proposes a mechanism leading to rigid pricing as an optimal strategy. It applies a framework of rational inattention to study the pricing strategies.
[62]
[PDF] Optimal sticky prices under rational inattention
The model can be used to study how the optimal allocation of attention and the dynamics of prices depend on the economic environment. In the model price setting ...
[63]
Sticky prices or rational inattention – What can we learn from ...
Sectors with sticky prices react less strongly and less quickly to macroeconomic shocks. This is more in line with multi-sector sticky-price models than with ...
[64]
[PDF] Rational inattention: a research agenda Christopher A. Sims
If rational inattention is to explain much of observed inertia in behavior, people must be using a small part of their capacity to monitor economic variables.
[65]
[PDF] Managerial and Customer Costs of Price Adjustment
According to the table, the physical menu cost comprises only 0.04% of the company's revenue. In contrast, the managerial and customer costs comprise 0.28% and ...<|separator|>
[66]
Menu costs, firm size and price rigidity - ScienceDirect.com
If menu costs involve a common lump-sum component, the cost of price adjustment per unit of output will fall systematically as firm size increases.
[67]
Firm Price-Setting Behavior Amid Elevated Price Growth
Mar 28, 2023 · As a part of this survey, we ask firms to report the 12-month percentage change in the prices they receive from customers for their goods or ...
[68]
[PDF] Estimates of Cost-Price Passthrough from Business Survey Data
The study estimates an average cost-price passthrough of around 60 percent, with meaningful heterogeneity across firms.
[69]
Downward Nominal Wage Rigidity and Sources of Business Cycle ...
May 5, 2022 · We consider a New Keynesian model with downward nominal wage rigidity (DNWR) and show that government spending is much more effective in stimulating output in ...
[70]
[PDF] Price Rigidities in U.S. Business Cycles - econ.umd.edu
Mar 19, 2025 · We present a structurally estimated time series of US aggregate price rigidities from 1978 to 2023. Our estimation uses a novel generalized ...
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[PDF] A plucking model of business cycles
Mar 14, 2025 · Finally, we review the empirical evidence on wage rigidity, and show that the incidence of wage rigidity is countercyclical. To implement our ...
[72]
[PDF] Still Minding the Gap—Inflation Dynamics during Episodes of ...
This paper studies inflation dynamics during 25 historical episodes of persistent large output gaps (PLOG) in advanced economies. We find that such episodes ...
[73]
The Inflation-Output Trade-Off with Downward Wage Rigidities
This paper investigates the macroeconomic implications of downward nominal wage rigidities in a low inflation environment via a dynamic stochastic general equi-.
[74]
[PDF] Firm-Specific Capital, Nominal Rigidities, and the Business Cycle
Jan 25, 2010 · Abstract. This paper formulates and estimates a three-shock US business cycle model. The estimated model accounts for a substantial fraction ...
[75]
[PDF] The Elusive Costs of Inflation: Price Dispersion during the U.S. Great ...
Rather than seeing an increase in the absolute size of price changes during the Great Inflation, we see a substantial increase in the frequency of price change.
[76]
The frequency of price adjustment: A study of the newsstand prices ...
The essay concludes that higher inflation leads to more frequent price adjustment and that the real cost of price changes varies with the size of a real price ...
[77]
Price setting frequency and the Phillips curve - ScienceDirect.com
The price setting frequency is positively related with inflation. It accelerates during demand-driven expansions implying an accelerating inflation. In contrast ...
[78]
Price-setting in a high-inflation environment - CEPR
Aug 7, 2023 · The corresponding change for time-dependent price-setters was a more modest increase from 11% to 17%. Figure 3 Frequency of price changes.
[79]
[PDF] setting evidence for inflation dynamics and monetary transmission
Overall, in the manufacturing sector, the frequency of price changes moves more closely in line with inflation when. PPI inflation is higher than 4% to 5%.<|separator|>
[80]
[PDF] Time-dependent versus state-dependent pricing: a panel data ...
Section 5 tries to assess the empirical importance of state-dependent pricing with respect to that of time-dependent pricing. Finally, our main conclusions are ...
[81]
[PDF] Are State and Time Dependent Models Really Different?
We analytically show that in several TD and SD models of the last generation, featuring idiosyncratic shocks, a small monetary shock does not have a first order ...
[82]
Are State- and Time-Dependent Models Really Different?
Time-Dependent Pricing Rules. We now describe a price-setting problem where ... “State-Dependent Pricing under Infrequent Information: A Unified Framework.
[83]
State-dependent or time-dependent pricing? New evidence from a ...
In time-dependent models, the probability of price change depends on the time elapsed since the previous change. In state-dependent models, the decision to ...
[84]
[PDF] Five Facts About Prices: A Reevaluation of Menu Cost Models
For example, the Calvo (1983) model and the Caplin and Spulber (1987) model have very different macroeconomic im- plications for the same frequency of price ...
[85]
[PDF] Does It Matter for Recent U.S. Inflation? - Pete Klenow
Monetary shocks typically have longer lasting real output effects in time-dependent pricing (TDP) models than in state- dependent pricing (SDP) models. 1 ...
[86]
[PDF] Time-dependent or state-dependent pricing? Evidence from a large ...
State-dependent and time-dependent price setting models yield distinct implications for how frequency and magnitude of price changes react to shocks. This note ...<|separator|>
[87]
[PDF] Monetary Non-Neutrality in a Multi-Sector Menu Cost Model
Much applied work in monetary economics relies on models in which nominal rigidities are the key friction that generates monetary non-neutrality. The workhorse ...
[88]
[PDF] Time- and State-Dependent Pricing: A Unified Framework
We develop a tractable unified framework for solving optimal time- and state-dependent price-setting problems. We illustrate our approach by solving a ...
[89]
[PDF] Menu costs - Princeton Economics
Each firm pays a fixed cost 𝜒𝑡 (𝑓 ) when adjusting its price from the price charged in the previous period.
[90]
[PDF] Calvo vs Menu Cost: A Micro-Macro Approach to Discriminate ...
We propose a new methodology to discriminate among models that uses both micro and macro moments to discipline model choice. The key insight lies in using.
[91]
Shocks versus Menu Costs: Patterns of Price Rigidity in an ...
Jul 1, 2022 · One main finding is that the time-dependent (Calvo) component of the pricing friction is the main source of price rigidity, whereas the genuine ...
[92]
[PDF] STAGGERED PRICE AND WAGE SETTING IN MACROECONOMICS
The staggered contract model developed in Taylor (1979a, 1980a) was explicitly designed to have these features; it is a simple model of price or wage setting ...
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[PDF] Measured Inflation and the New-Keynesian Model
Nov 7, 2024 · The standard new-Keynesian (NK) model incorporates nominal rigidities via Calvo-style frictions according to which firms update prices with ...
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[PDF] MA Advanced Macro, 2016 (Karl Whelan) 1 The Calvo Model of ...
The New-Keynesian Phillips Curve. So, the dynamics of pricing in the Calvo model can be summarized by the two equations pt. = (1 − α)xt + αpt−1. (17) xt. = (1 ...
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[PDF] NOMINAL AND REAL WAGE RIGIDITIES IN THEORY AND IN ...
The simplest explanation for the existence of real wage rigidities sees them as a conse- quence of two nominal rigidities: a nominal price rigidity and a ...
[96]
[PDF] Price Rigidity: Microeconomic Evidence and Macroeconomic ...
We discuss empirical evidence on these and other important features of micro price adjustment and ask how they affect the sluggishness of aggregate price ...
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[PDF] Policy Paradoxes in the New Keynesian Model
An alternative model of nominal rigidities, albeit one less typically employed, is the sticky-information model of Mankiw and Reis [2002]. As highlighted ...
[98]
[PDF] Trend Inflation, Indexation, and Inflation Persistence in the New ...
In this paper we consider the extent to which Guillermo Calvo's (1983) model of nominal price rigidities can explain inflation dynamics without relying on ...Missing: mathematical amplification
[99]
[PDF] New Pricing Models, Same Old Phillips Curves? Adrien Auclert ...
The nature of nominal rigidities is a central question in monetary economics. In sticky-price mod- els, monetary policy has aggregate effects because producers' ...
[100]
[PDF] Nonlinear Dynamics in Menu Cost Economies? Evidence from U.S. ...
For example, the cumulative impulse response to a 1% monetary shock is 0.14 of that predicted by the Calvo model with the same average fraction of price changes ...
[101]
[PDF] Evaluating the Calvo Model of Sticky Prices∗
Can variants of the classic Calvo (1983) model of sticky prices account for the statistical behavior of post-war US inflation? We develop and test versions ...
[102]
Nominal wage rigidity in macro: an example of methodological failure
Oct 12, 2013 · Behavioural economics just does not get a look in. A good and very important example comes from the reluctance of firms to cut nominal wages.Missing: challenges | Show results with:challenges
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Behavioral economics and macroeconomic models - ScienceDirect
First, it has become clear to macroeconomists that models based on assumptions of optimizing behavior in many cases have difficulty accounting for key real- ...
[104]
[PDF] Real Business Cycle Models: Past, Present, and Future*
Real business cycle models use dynamic general equilibrium models with atomistic agents, rational expectations, and are calibrated with microeconomic studies.
[105]
[PDF] The Austrian Theory of Business Cycles: Old Lessons for Modern ...
... Austrian business cycle theory do not provide a satisfactory explanation for economic fluctuations, the insights in the nature of business cycles and the ...
[106]
Business Cycles - Econlib
Only when prices and inflationary expectations are not fully flexible can fluctuations in overall demand cause large swings in real output.<|control11|><|separator|>
[107]
What Is Monetarism? - Back to Basics
Monetarism maintains that the money supply (the total amount of money in an economy) is the chief determinant of current dollar GDP in the short run and the ...
[108]
Business Cycles Explained: Monetarist Theory - Libertarianism.org
Jul 26, 2012 · Monetarism claims that money supply fluctuations drive the rate of inflation and deflation. Notable monetarist Milton Friedman proposed that ...
[109]
Some Evidence on the Importance of Sticky Prices | NBER
Jul 18, 2002 · We examine the frequency of price changes for 350 categories of goods and services covering about 70% of consumer spending, based on unpublished data from the ...
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https://www.aeaweb.org/articles?id=10.1257/aer.98.5.1941
[111]
[PDF] Real Business Cycles: A New Keynesian Perspective
Nominal variables, such as the money supply and the price level, are assumed to have no role in explaining fluctuations in real variables, such as output and ...
[112]
How Well Does the New Keynesian Sticky-Price Model Fit the Data?
Jan 29, 2021 · I find that the New Keynesian model does not fit the U.S. data well; in particular, the model requires additional lags of inflation not implied ...
[113]
Downward Nominal Wage Rigidity and Sources of Business Cycle ...
In a New Keynesian model with downward nominal wage rigidity (DNWR), we show that government spending is more effective in stimulating output in a low-inflation ...
[114]
About a rate of (general) interest: how monetary policy transmits
Jul 12, 2024 · A consequence of nominal rigidities is that changes in the stance of monetary policy are not immediately offset by changes in the price level – ...1: Introduction · 2: The importance of nominal... · 3: The channels of monetary...
[115]
[PDF] The Monetary Transmission Mechanism
The monetary transmission mechanism describes how policy-induced changes in the nominal money stock or the short-term nominal interest rate impact real.
[116]
[PDF] Nominal Rigidities and the Dynamic Effects of a Shock to Monetary ...
This result is reminiscent of Chari, Kehoe and McGrattan's (2000) finding that, in models where the only nominal rigidity is sticky prices, monetary policy ...
[117]
Sticky prices and the transmission mechanism of monetary policy
Sticky prices and the transmission mechanism of monetary policy: A minimal test of New Keynesian models. Author & abstract; Download; 55 References; 2 Citations ...
[118]
[PDF] Sectoral output effects of monetary policy: do sticky prices matter?
The results suggest that sticky prices play an important role in the transmission of monetary policy, con- sistent with New Keynesian macroeconomic models. This ...
[119]
Sectoral Output Effects of Monetary Policy: Do Sticky Prices Matter?
Oct 5, 2020 · The results suggest that sticky prices play an important role in the transmission of monetary policy, consistent with New Keynesian ...
[120]
[PDF] Does Inflation “Grease the Wheels of the Labor Market”?
An implication of this downward rigidity hypothesis is that inflation can ease labor market adjustments by speeding the decline in wages for individuals and ...
[121]
Nominal rigidities and the optimal rate of inflation - ScienceDirect.com
The essential argument in the preceding analysis is that nominal prices and wages are more rigid, especially in a downward direction, at low rates of inflation.
[122]
[PDF] Does Inflation 'Grease the Wheels of the Labor Market'?
These counterfactual distributions suggest that a 1 percent increase in the inflation rate reduces the fraction of workers with downward-rigid wages by about ...
[123]
Considerations in Reducing Inflation From Low to Lower Levels
The authors conclude that a 1 percent increase in the rate of inflation reduces the portion of workers with nominal wage rigidities by about 0.8 percent and ...
[124]
Downward nominal wage rigidity and the optimal inflation target
May 23, 2025 · The optimal inflation rate is estimated to be as high as 8.8%, and increasing the inflation target to the optimal level yields a welfare gain of nearly 3.50%.
[125]
[PDF] Revisiting the Optimal Inflation Rate with Downward Nominal Wage ...
Oct 30, 2020 · Reflecting the larger “grease the wheels” effect, the optimal inflation rate obtained in the heterogeneous agent model is substantially higher.
[126]
[PDF] Identifying Inflation's Grease and Sand Effects in the Labor Market
Grease and sand effects can both arise from nominal rigidities in wages or prices in the face of shocks. Beyond that shared characteristic, however, the.
[127]
[PDF] Endogenous growth, downward wage rigidity and optimal inflation
Deviations from the optimal inflation target, which we find to be above 2 percent, carry non-trivial welfare costs amidst the non-neutrality implied by ...Missing: debates | Show results with:debates
[128]
[PDF] The Optimal Inflation Target and the Natural Rate of Interest
ABSTRACT We study how changes in the steady-state real interest rate. (henceforth r*) affect the optimal inflation target in a New Keynesian dynamic.<|separator|>