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Wednesday, June 03, 2015

'Coordination Equilibrium and Price Stickiness'

This is the introduction to a relatively new working paper by Cidgem Gizem Korpeoglu and Stephen Spear (sent in response to my comment that I've been disappointed with the development of new alternatives to the standard NK-DSGE models):

Coordination Equilibrium and Price Stickiness, by Cidgem Gizem Korpeoglu (University College London) Stephen E. Spear (Carnegie Mellon): 1 Introduction Contemporary macroeconomic theory rests on the three pillars of imperfect competition, nominal price rigidity, and strategic complementarity. Of these three, nominal price rigidity (aka price stickiness) has been the most important. The stickiness of prices is a well-established empirical fact, with early observations about the phenomenon going back to Alfred Marshall. Because the friction of price stickiness cannot occur in markets with perfect competition, modern micro-founded models (New Keynesian or NK models, for short) have been forced to abandon the standard Arrow-Debreu paradigm of perfect competition in favor of models where agents have market power and set market prices for their own goods. Strategic complementarity enters the picture as a mechanism for explaining the kinds of coordination failures that lead to sustained slumps like the Great Depression or the aftermath of the 2008 …financial crisis. Early work by Cooper and John laid out the importance of these three features for macroeconomics, and follow-on work by Ball and Romer showed that failure to coordinate on price adjustments could itself generate strategic complementarity, effectively unifying two of the three pillars.
Not surprisingly, the Ball and Romer work was based on earlier work by a number of authors (see Mankiw and Romer's New Keynesian Economics) which used the model of Dixit and Stiglitz of monopolistic competition as the basis for price-setting behavior in a general equilibrium setting, combined with the idea of menu costs -- literally the cost of posting and communicating price changes -- and exogenously-specified adjustment time staggering to provide the friction(s) leading to nominal rigidity. While these models perform well in explaining aspects of the business cycle, they have only recently been subjected to what one would characterize as thorough empirical testing, because of the scarcity of good data on how prices actually change. This has changed in the past decade as new sources of data on price dynamics have become available, and as computational power capable of teasing out what might be called the "…fine structure" of these dynamics has emerged. On a different dimension, the overall suitability of monopolistic competition as the appropriate form of market imperfection to use as the foundation of the new macro models has been largely unquestioned, though we believe this is largely due to the tractability of the Dixit-Stiglitz model relative to other models of imperfect competition generated by large …fixed costs or increasing returns to scale not due to specialization.
In this paper, we examine both of these underlying assumptions in light of what the new empirics on pricing dynamics has found, and propose a different, and we believe, better microfoundation for New Keynesian macroeconomics based on the Shapley-Shubik market game.

    Posted by on Wednesday, June 3, 2015 at 12:45 PM in Academic Papers, Economics, Macroeconomics, Methodology | Permalink  Comments (4)


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