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Some Evolutionary Foundations for Price Level Rigidity
The American Economic Review
Vol. 95, No. 3 (Jun., 2005), pp. 765-779
Published by: American Economic Association
Stable URL: http://www.jstor.org/stable/4132739
Page Count: 15
You can always find the topics here!Topics: Prices, Price levels, Macroeconomics, Price shocks, Experimentation, International economics, Economic inflation, Experimental economics, Simulations, Price rigidities
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This paper shows that price rigidity evolves in an economy populated by imperfectly rational agents who experiment with alternative rules of thumb. In the model, firms must set their prices in face of aggregate demand shocks. Their payoff depends on the level of aggregate demand, as well as on their own price and their "neighbor's" price. The latter assumption captures local interactions. Despite the fact that the rational expectations equilibrium (REE) is characterized by a simple pricing rule that firms can easily adopt, the economy does not converge to the REE for all parameter values. When the volatility of monetary innovations is low and interactions among firms are high, the aggregate price level exhibits rigidity, in that it does not fully react to contemporaneous aggregate demand shocks. We discuss the role of the nature of experimentation, and of path dependence driven by interactions, in explaining these results.
The American Economic Review © 2005 American Economic Association