|Author Name||CHEN Cheng (Clemson University) / SENGA Tatsuro (Fellow (Specially Appointed), RIETI) / SUN Chang (University of Hong Kong) / ZHANG Hongyong (Senior Fellow, RIETI)|
|Creation Date/NO.||October 2020 20-E-078|
|Research Project||Studies on the Impact of Uncertainty and Structural Change in Overseas Markets on Japanese Firms|
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What makes prices sticky? While it is commonly understood that prices adjust only sluggishly to changes in economic conditions, the cause of sluggish price adjustment is underexplored empirically. In this paper, we argue that sluggish updating of information drives price stickiness. To this end, we use a panel dataset that contains information on both firm-level expectations and price adjustments and document the following facts: (1) there is a positive correlation between whether a firm updates its expectations and whether it adjusts prices; (2) firms update expectations more frequently and make less correlated forecast errors in downturns; and (3) firms adjust prices more frequently in downturns. We then extend an Ss price-setting model with second moment shocks to allow for endogenous information acquisition by the firm. The model predicts that firms acquire information more intensively during periods of high volatility, also adjusting expectations and prices more often. Countercyclical volatility, interacting with menu costs and information rigidity, is what drives our results. This implies that the flexibility of the aggregate price level is counter-cyclical, making monetary policy less effective in recessions.