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14 - Information acquisition and nominal price adjustment

Published online by Cambridge University Press:  13 October 2009

Huw David Dixon
Affiliation:
University of York
Neil Rankin
Affiliation:
University of Warwick
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Summary

Introduction

The failure of prices to adjust plays a crucial role in Keynesian macroeconomics. In particular the failure of nominal prices to adjust instantaneously to nominal shocks is important for the role of demand shocks as a source of business cycle fluctuations. Empirical evidence shows that nominal shocks contribute to business cycle fluctuations (see, for example, Andersen, 1994). Insufficient price adjustment may at a general level be caused by either adjustment being costly in terms of explicit or implicit costs or by pricesetters lacking sufficient information to make the proper adjustment.

The most widespread model of price inflexibility is the so-called menu cost model, assuming price adjustment to be costly. This model has recently been extensively analysed (see Ball, Mankiw and Romer, 1988 and Andersen, 1994 for introductions and references) and has provided a number of important insights on price adjustment. Still, the empirical relevance of price adjustment costs remains an open question, and it is not obvious whether price adjustment costs are more important than costs of adjusting quantities.

An alternative approach to the explanation of price rigidities is to consider informational problems arising in decentralized economies. Small departures from the benchmark case of full information are sufficient to cause adjustment failures, especially if firms are differently informed or if there is confusion between permanent and transitory changes (see Andersen, 1994). In this chapter we extend the analysis of informational problems by making information acquisition by actors in the economy explicit.

Type
Chapter
Information
The New Macroeconomics
Imperfect Markets and Policy Effectiveness
, pp. 293 - 306
Publisher: Cambridge University Press
Print publication year: 1995

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