State-Dependent Pricing and the Dynamics of Money and Output

Authors:
  • ACAndrew Caplin
    Andrew Caplin
  • JLJohn Leahy
    John Leahy
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Abstract
Standard macroeconomic models of price stickiness assume that each firm leaves its price unchanged for a fixed amount of time. We present an alternative model in which the pricing decision depends on the state of the economy. We find a method of aggregating individual price changes that allows a simple characterization of macroeconomic variables. The model produces a positive money-output correlation and an empirical Phillips curve. In addition, the impact of monetary shocks depends crucially on the current level of output, which points to a natural connection between state-dependent microeconomics and state-dependent macroeconomics.