Inflation and Output Dynamics with State-Dependent Frequency of Price Changes

Abstract

This paper extends Calvo's (1983) time-dependent pricing model to incorporate state-dependent features in pricing, while preserving tractability. The pricing scheme delivers a generalized New Keynesian Phillips curve with an explicit role for the frequency of price revisions. The novel feature shows that inflation responds to movements of relative prices and to endogenous fluctuations in the average frequency of price adjustment. The model offers, therefore, a microfounded rationale for systematic deviations in the inflation- marginal cost relation predicted by the new Keynesian Phillips curve. As a byproduct, the model determines endogenously the short-run slope of the Phillips curve. Simulations predict weaker responses of output and stronger responses of inflation to technology, preference and monetary shocks than those of a close time-dependent model.