Microeconomic Rigidities and Aggregate Price Dynamics

This paper is an attempt to enrich the characterization of the sluggish behavior of the aggregate price level. Our contribution to this vast literature is to explicitly consider microeconomic heterogeneity and its interaction with nonlinear microeconomic price adjustment policies. The model we propose outperforms the constant-probability-of-adjustment/partial- adjustment model in describing the path of postwar U.S. inflation. Using only aggregate data, we infer that the probability that a firm adjusts its price depends on the sign and the magnitude of the deviation of the price from its target level. At the aggregate level we find that the aggregate price responds less to negative shocks than to positive shocks, that the size of this asymmetry increases with the size of the shock, and that the number of firms changing their prices - and therefore the flexibility of the price level to aggregate shocks - varies endogenously over time in response to changes in economic conditions.