Discussion Paper Series 2006-E-23

Do Sticky Prices Need to Be Replaced with Sticky Information?

Bill Dupor, Tomiyuki Kitamura, Takayuki Tsuruga

A first generation of research found it difficult to reconcile observed inflation and cyclical output with the fixed price mechanism. Since then, researchers have been divided roughly into two camps. The first camp argues that the original mechanism is largely successful once cyclical output is replaced with labor's share. The second camp argues for a wholesale replacement of fixed prices, e.g., with 'sticky information.' We take up the question by estimating a 'dual stickiness' model that integrates sticky prices and information. We find that both rigidities are present in aggregate U.S. data. Thus, sticky information cannot replace sticky prices. Our dual stickiness model performs comparably to the hybrid sticky price model, which allows for a fraction of backward-looking firms. In particular, the hybrid model's backward-looking behavior arises endogenously under dual stickiness. As such, the dual stickiness model (with an estimated seven month average information delay) may provide more plausible microeconomic foundations.

Keywords: Inflation; Sticky Price Model; Sticky Information Model; Labor Share

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2006 Bank of Japan All Rights Reserved.

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