“The (Q,S,s) Pricing Rule,” with Kenneth Burdett, Review of Economic Studies, 2018, 85 (2), 892-928.
We introduce menu costs in the search-theoretic model of imperfect competition of Burdett and Judd (1983). When menu costs are not too large, the equilibrium is such that sellers follow a (Q,S,s) pricing rule. According to the rule, a seller lets inflation erode the real value of its nominal price until it reaches some point s. Then, the seller pays the menu cost and resets the real value of its nominal price to a point randomly drawn from a distribution with support [S,Q], where s<S<Q. A (Q,S,s) equilibrium differs with respect to a standard (S,s) equilibrium: (i) In a (Q,S,s) equilibrium, sellers sometimes keep their nominal price constant to avoid paying the menu cost, other times because they are indifferent to changes in the real value of their price. An exploratory calibration reveals that menu costs account less than half of the observed duration of nominal prices. (ii) In a (Q,S,s) equilibrium, higher inflation leads to higher real prices, as sellers pass onto buyers the cost of more frequent price adjustments, and to lower welfare.
“The (Q,S,s) Pricing Rule: A Quantitative Analysis,” with Kenneth Burdett, Research in Economics, 2017, 71 (4), 784-797.
Are nominal prices sticky because menu costs prevent sellers from continuously adjusting their prices to keep up with inflation or because search frictions make sellers indifferent to any real price over some non-degenerate interval? The paper answers the question by developing and calibrating a model in which both search frictions and menu costs may generate price stickiness and sellers are subject to idiosyncratic shocks. The equilibrium of the calibrated model is such that sellers follow a (Q,S,s) pricing rule: each seller lets inflation erode the effective real value of the nominal prices until it reaches some point s and then pays the menu cost and sets a new nominal price with an effective real value drawn from a distribution with support [S,Q], with s<S<Q. Idiosyncratic shocks short-circuit the repricing cycle and may lead to negative price changes. The calibrated model reproduces closely the properties of the empirical price and price-change distributions. The calibrated model implies that search frictions are the main source of nominal price stickiness.
“Monetary Theory with Non-Degenerate Distributions,” with Shouyong Shi and Hongfei Sun, Journal of Economic Theory, 2013, 148 (6), 2266-2312.
We construct and analyze a tractable search model of money with a non-degenerate distribution of money holdings. We assume search to be directed in the sense that buyers know the terms of trade before visiting particular sellers. Directed search makes the monetary steady state block recursive in the sense that individuals’ policy functions, value functions and the market tightness function are all independent of the distribution of individuals over money balances, although the distribution affects the aggregate activity by itself. Block recursivity enables us to characterize the equilibrium analytically. By adapting lattice-theoretic techniques, we characterize individuals’ policy and value functions, and show that these functions satisfy the standard conditions of optimization. We prove that a unique monetary steady state exists. Moreover, we provide conditions under which the steady-state distribution of buyers over money balances is non-degenerate and analyze the properties of this distribution.
“Sticky Prices: A New Monetarist Approach,” with Allen Head, Lucy Qian Liu and Randall Wright, Journal of the European Economic Association, 2012, 10 (5), 939-973 (Lead article).
Why do some sellers set prices in nominal terms that 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 money increases, some sellers keep prices constant, earning less per unit but making it up on volume, so profit is unaffected. The model is consistent with the micro data. But, in contrast with other sticky-price models, money is neutral.
“Inflation and Unemployment in the Long Run,” with Aleksander Berentsen and Randall Wright, American Economic Review, 2011, 101 (1), 371-398.
We study the long-run relation between money (inflation or interest rates) and unemployment. We document positive relationships between these variables at low frequencies. We develop a framework where money and unemployment are modeled using explicit microfoundations, providing a unified theory to analyze labor and goods markets. We calibrate the model and ask how monetary factors account for labor market behavior. We can account for a sizable fraction of the increase in unemployment rates during the 1970s. We show how it matters whether one uses monetary theory based on the search-and-bargaining approach or on an ad hoc cash-in-advance constraint.