Econ 702 Macroeconomics I

Charles Engel and Menzie Chinn

Spring 2020

Lecture 16: Price Rigidity

Organization

•Course website https://www.ssc.wisc.edu/~mchinn/web702s2_s20.html• TA Website https://www.junkim666.com/econ702-

spring-702.htmlhttps://www.junkim666.com/econ702-spring-702.html•Problem Sets on Chinn website, TA Website- Policy on Problem Sets: work together, but submit

individual problem set answers!• Slides online before lectures•Office hours Tu, Th 1:30-2:30

Outline

•Review• Where we’re headed: supply side and equilibrium•Review of Aggregate Demand•Neoclassical Supply Side•Price Rigidity•Preview - New Keynesian Supply Side

Where we are headed

IS-LM-AD-AS, combines Keynesian and New Classical attributes w/forward looking expectations

The IS-LM-AD Model

•New Keynesian - expectations matter•This version incorporates neo-Ricardian equivalence•Old Keynesian - uses the Hicksian decomposition•But yields largely the same results that monetary

and fiscal policy can be effective•Can dichotomize economy into real and financial

sides, where individual agents separately solve for real activities and for asset choices•For exposition at beginning, assume the price level

can be held constant

The IS-LM-AD Model

Summary of IS-LM

Aggregate Demand

Policy in Aggregate Demand

Shocks in Aggregate Demand

Summary of AD

IS-LM-AD-AS

Neoclassical Aggregate Supply: Equations

Neoclassical Aggregate Supply: Graphical

Neoclassical AS: Shifts due to Technology

Neoclassical AS: Shifts due Increased Disutility of Work

Are Perfectly Flexible or Sticky?

•The Neoclassical aggregate supply curve assumes perfectly flexible prices (over some horizon).•What if prices are not perfectly flexible?•We can do extreme cases– Perfectly fixed– Partly fixed•What’s the evidence?•See Nakamura-Steinsson

If Prices Are Partly Flexible

Price Rigidity Documented

An Example: One Specific Good

Frequency of Consumer Price Changes

Exogenous or “Predetermined” Price Level

Predetermined Price Level: Shifts

Preview: New Keynesian Aggregate Supply

Preview: New Keynesian Aggregate Supply

Preview: New Keynesian Aggregate Supply

Preview: New Keynesian Aggregate Supply

Conclusions

•The Neoclassical model is useful for some problems•But prices appear to be sticky•A more appropriate model is one where prices are sticky but not too sticky•This leads to a model where shocks have different effects than in a Neoclassical model