Inflation and real activity with firm-level productivity shocks: a quantitative framework ∗

Abstract

Recent measurements of the extent of price stickiness indicate that there is a substantial amount of relative price variability. Extending our prior state-dependent pricing model, we study a setting in which there are discrete micro states interpreted as stochastic productivity variations at the firm level. The new model shares the generalized partial implications of our prior analysis and also its tractability for macroeconomic analysis. Notably, it can be used to study the strength of general equilibrium influences on price adjustment and the consequences of alternative monetry policy rules. Without aggregate uncertainty, the microstate model has rich implications for the dynamics of prices, including links from firm level productivity to the likelihood of price adjustment (”conditional hazards”) and magnitudes of price adjustments. In this steady state — where firms face substantial uncertainties while aggregates are constant — there are also implications for the cross-sectional distribution of relative prices and price changes, among other things. When linearized around this stationary point, the microstate model also has important implications for the dynamic of aggregate economic activity. To exposit these, we build quantitative examples which we link to recent studies in the literature.

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