Some evolutionary foundations for price level rigidity

Gilles Saint-Paul

Research output: Contribution to journalReview articlepeer-review

Abstract

This paper shows that price rigidity evolves in an economy populated by imperfectly rational agents who experiment with alternative rules of thumb. In the model, firms must set their prices in face of aggregate demand shocks. Their payoff depends on the level of aggregate demand, as well as on their own price and their "neighbor's" price. The latter assumption captures local interactions. Despite the fact that the rational expectations equilibrium (REE) is characterized by a simple pricing rule that firms can easily adopt, the economy does not converge to the REE for all parameter values. When the volatility of monetary innovations is low and interactions among firms are high, the aggregate price level exhibits rigidity, in that it does not fully react to contemporaneous aggregate demand shocks. We discuss the role of the nature of experimentation, and of path dependence driven by interactions, in explaining these results.

Original languageEnglish (US)
Pages (from-to)765-779
Number of pages15
JournalAmerican Economic Review
Volume95
Issue number3
DOIs
StatePublished - Jun 2005

ASJC Scopus subject areas

  • Economics and Econometrics

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