The Responsiveness of Prices to Aggregate Technology Shocks and Monetary Policy Shocks

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I show that the speed of price adjustment to aggregate technology shocks is substantially larger than to monetary policy shocks. In the context of large Bayesian Vector Autoregression models, I establish that aggregate and disaggregate prices adjust very quickly to technology shocks, while they only respond sluggishly to monetary policy shocks. I derive explicit measures of difference in price responsiveness. Under the benchmark specification, aggregate prices accomplish half of their long-run response to a permanent technology shock 6 quarters before they accomplish half of their long-run response to a monetary policy shock. I show that these results are very robust across different identification schemes, models specifications and data definitions. Looking at disaggregated producer prices responses to the two aggregate shocks, I find that prices adjust faster to technology shocks in about 85% of industries. I also find that industries where prices are more volatile tend to be the industries with the smaller difference in price responsiveness to the two shocks. I show that the difference in the speed of price adjustment to the two types of shocks arises naturally in a model where price setting firms optimally decide what to pay attention to, subject to a constraint on information flows. In my model, firms pay more attention to technology shocks than to monetary policy shocks when the former affects profits more than the latter. Furthermore, strategic complementarities in price setting generate complementarities in the optimal allocation of attention. Therefore, each firm has an incentive to acquire more information on the variables that the other firms are, on average, more informed about. These complementarities induce a powerful amplification mechanism of the difference in the speed with which prices respond to technology shocks and to monetary policy shocks. Finally, I show that the monetary policy rule may influence substantially the difference in price responsiveness by affecting the allocation of attention decision by firms. I compare the implications about relative price responsiveness to the two shocks from my model to the ones from a more standard model of nominal price rigidities. I show that these two classes of models have potentially very different implications for monetary policy in terms of relative price responsiveness.

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  • 09/18/2018
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