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Your narrative objectifies the store. Surely the store observes the quantity exchanged and adjusts it's prices too, or things are different in Canada.

In my experience, processed foods have constant prices and fresh foods have highly variable prices. The reason should be clear, processed foods take commodity inputs and warehouse well.

Jon: presumably the store does adjust prices in response to changes in demand and costs, but does so infrequently. Remember my post at the end of May? I came back from a 4 day canoe trip to find the value of my loonie had changed a lot in the forex market and the stock market, but not at the supermarket.

The price of fresh food does vary much more. But usually between fixed price points (e.g. 99c/lb=$2.18 per kg). So I don't know if it's really varying in the way that theory says it should.

Crude oil is like processed food: a commodity that warehouses well. But its price varies continuously. Gold too. Why not cans of sardines?

I'm lost in the 3 paragraphs 2 off from the end.

Just to be clear,

"Sticky nominal prices, if they are the prices that determine how much money changes hands when people take delivery of goods, cannot be a facade"
follows from the previous sentence, on the real effect of peoples ability for transactions,

meaning:
The sticky prices are sellers taking into account the looming inefficiencies of lower money supply.

And how does this compare to the monopolistic competition sticky prices, of the grocery store.
" But whatever it is that causes sticky prices, it's something on the supply-side "

I don't think you are giving discounts to "list price" (couponing, sales, and non-price promotions) their due. Firms typically discuss these as "giving up 2 points of pricing because the environment was promotional". Further, I agree with Jon--the "outer ring" of a supermarket (fresh items) has quite variable prices, and the range you observe may just be a function of the limited variation in input costs.

Truly sticky-price supermarket items that are ultimately a sign of imperfect competition. These firms will hold nominal prices and let output vary, but only because their input cost inflation expectations are tame. In higher-inflation countries, this is not the case, and bar-coding allows for fairly constant changes in supermarket prices. This renders the concept of "sticky prices" tautological. In other words, "prices are sticky because input costs are sticky; and input costs are sticky because prices are sticky."

Does one explain sticky up, and the other sticky down?

@Jon
See this paper for some work on that topic: http://www.nber.org/papers/w13829
The gist is that nominal rigidities do not necessarily take the form of sticky prices, but may take the form of sticky "reference prices" that adjust infrequently and prices regularly return to.

edeast: sorry, but you lost me on your "you lost me" comment. Which bit don't you understand?

The sentence: "And the fact of monetary exchange means that sticky prices cannot just be a facade." states the thesis of a new argument put forward in the paragraph which it begins. It's not a summary of the argument above. You could even delete that paragraph and the rest of the post would still cohere.

Does that help clarify?

David: imperfect competition does not explain sticky prices (though it might make sticky prices *easier* to explain, since the loss in profits of failing to adjust prices are lower under imperfect competition). And even if MC curves were flat, and elasticities of demand constant, all you get are sticky *real* (relative( prices at the individual firm level, not sticky *nominal* prices at the *aggregate* level.

jsalvati: good find! That was exactly what I had in mind when I was talking about "temporary sales" in the post, and "fixed price points" in my response to Jon. Is that Eichenbaum et al paper the seminal paper on that point? (I think it is, but my brain is mush -- especially in the heat here this last few days, 34C!).

"I don't know why my supermarket has sticky prices."

You could ask them? But I guess that wouldn't be scientific.

If you don't know why your supermarket has sticky prices, you could ask them.

I'm amazed at the tendency for academic economists to invent puzzles where none exist.

here’s how I read it,
The first part of the blog concerns, sticky prices, and the monopolistic competition,
You explain grocery store sticky prices are marshallian, then you describe how the labor market doesn’t matter, because “Given sticky output prices, sticky wages and other input prices are irrelevant.”
I wouldn’t mind an explanation of your monopolistic competition, maybe now with graphs ;) (A stronger or simpler proof of sticky output prices.)

The confusion I’m having is with the second part of the essay where you describe the hidden assumption of sticky prices. I read those paragraphs as building a case.

Paragraph 1, describes whether a marshallian or walrusian,

Paragraph 2, describes the assumption,
“…,sticky-price macroeconomists are implicitly assuming a monetary exchange economy” ie marshallian.

Paragraph 3, is your defense, on your intuition, that recessions are caused by “excess demand for the medium”

Paragrah 4. The assumption becomes fact. You assert with the beginning sentence and the final sentence that sticky prices are not a façade. And the middle sentences are I take it your attempt, at guessing why. If you halv the money supply, frictions are introduced. Ineffeciencies etc.

So I took that as meaning, the sticky prices value came from the frictions of the monetary recession. And I was trying to compare this to your previous output sticky prices. Now you want to delete this paragraph but I find it the most interesting.

Darren: It's been tried. Robert Hall (? IIRC) did it 30 years ago. It's worth doing, but it doesn't really answer the question. It's a bit like asking giraffes why they have long necks. Even if giraffes could speak our language, it wouldn't really distinguish the Darwinian from the Lamarkian(sp?) theories.

"Sticky prices" is really a system property, not merely an individual firm property. (You can build models where each individual price is sticky but the average price level is perfectly flexible, Caplin and Spulber?). Plus the individual firm might know only that "it works", not *why* it works. Same with giraffes.

edeast: thanks for explaining. Damn! I didn't write that post clearly enough. The logical structure of the essay isn't transparent.

Paragraph 4 ("And the fact of monetary exchange means that sticky prices cannot just be a facade.....") is really just an aside. I'm throwing an extra stone at Barro's 1977 argument, showing that it can't work even if you do follow all his assumptions.

I'm going to stick brackets around that whole paragraph. An ugly fix, but better than nothing.

Your asides and blogging style, allow non-economists to get some traction. My fault for not understading Barro, but I do have my preferred, mental model, that I'm trying to build a case for so responsibility lies with readers as well.

This discussion reminds me of fascinating explanation I heard from Max Keiser about the role of market specialists in the stock market. This was done in the context of explaining high-frequency trading and the role of virtual market specialists in the Flash Crash last May.

Max Keiser does a radio internet show out of London& Paris. A former stock trader in the 80's, in the 90's he invented the Hollywood Virtual Exchange, and the virtual market specialist module is the basis for many of the high frequency trading programs used by the big Wall Street banks today.

In the stock market, bids and offers come in randomly, and in the short run very rarely match. So in order to have a stable market and smooth price changes, "market specialists" are specialized traders that hold inventories of stock, and can see in-coming orders, and they use their inventories to offset short-term gaps in supply and demand. So prices fluctuate not so much because of the immediate supply and demand conditions, but more from the of the expectations of the market specialists about the longer-term trend in market conditions.

So, to bring this to your example of the grocery store, the store acts as a market specialist, keeping inventories of groceries, and they have a superior knowledge of market conditions as compared to most sellers and buyers in the food market. Instead of adjusting prices instantaneously based on instantaneous fluctuations in suppply and demand, the retailer will use adjustements in their inventories to match immediate demand and supply, and will only change prices slowly according to their expectations of the more general trend of supply and demand conditions.

In short, if you see a market with stable or smoothly changing prices, that's probably because their are "market specialists" managing holdong inventories and using them to manage short-term fluctuations in supply and demand.

Max Keiser's radio and TV shows can be watched or listened to via his website at maxkeiser.com

I don't believe prices are sticky. Gray's Papaya has a recession special (2 hot dogs and a drink $4.45 instead of 5.45).

Nick, In your comment you referred to models where individual prices are fixed and the overall price level is flexible. I seem to recall reading the following about price stickiness:

1. If individual prices fully adjust whenever the current price is more than X% out of equilibrium, then individual price stickiness doesn't create aggregate price stickiness.
2. If individual prices fully adjust after X period of time, then individual price stickiness does create aggregate price stickiness.

Does that sound right? I suppose that's one reason I have always put more weight on wage stickiness, which fits the second category.

I was surprised that at the end of David's paper he indicated that his real target wasn't just sticky price models, but any model where nominal shocks have real effects. He seems perplexed that some economists would believe in models that imply that the 50% fall in US NGDP between 1929 and 1933 might have actually had some sort of causal role in the Great Depression. Alternatively, he seems to think that if whatever had caused the Great Depression had not happened, then a 50% fall in NGDP would not have created even a minor recession.

I've devoted too much of my life to economic history to find those sorts of models plausible.

Nick, no disagreement that commodity (spot) prices are volatile. My point is that a quantity variation in a given processed food is unlike to move the commodity markets because they are much deeper than a single consumer good, and that its very easy to hedge against price fluctuations.

I think your case about markets routinely differ from the model is unsubstantiated. The big sources of sticky prices are labor contracts, good-will, and rented capital.

jsalvati,

I've reviewed that paper. My thoughts: the paper is really much more effective at damaging the claim of monopolistic competition in the retail grocery market. This comports with my knowledge of the business that its based on razor-thin margins.

The authors claim that the retailers appear to set their prices based on cost but attenuate cost fluctuations as well. Again, this comports well with my understanding of the business: there are fixed costs associated with the price changes. Given some budget constraint, the retailer will strategically change prices, but its not optimal to change all prices, all the time.

The retailers appear to pass-thru costs because their production function is irrelevant for determining prices. Its the aggregate production function that matters. i.e., variations in consumer demand and producer supply change the equilibrium prices of the costs. If one store receives rush orders, the store usually reacts by withdrawing from the sale of that item because the store is a price taker. Other stores can and will supply at the old passthru cost.

I use to think that the stickiness i relative -the result of relative slow change in prices. There are assets, that are very quicly in adjust their prices, and there are good markets, very more slowly, and labor market, very very slow, indeed. So, these different velocity of adjustment make trouble in money market, because the velocity of circulation fall, and money disappear from some market.
If the velocity to adjust were the same in all markets, I suppose there will be no problem -the quantity of money need not to be adjusted to maintain the level of activity: Perfect Say´s law working!. So I think that the different velocity of price adjustment is the problem.
So, I agree with your argument, it explain very well the stickiness, but I think that the real problem is the big difference in changes in prices.

I think you need to think of employment as a long term contract, not a spot price.

Both the employee and the firm view employment as a long term relationship, much like a marriage, that will last through significant market fluctuations. It is to the advantage of both to ignore short run fluctuations.

But a spot price is just a momentary relationship that does not last longer than a very short time and may not be valid after that. At another time it may take a very different price to clear a spot market. But that does not apply to a long term contract. Even long term contracts to supply and purchase a good typically include terms to change the price if conditions change. For example, firms may buy and sell a volume of a good at a certain price, but if volume fall below or rises above that amount the price may also rise or fall for the higher(lower) amount.

I think I get it now.
Is it true that anonymity of buyers or sellers underlies explicit models? because David's whole post seemed to be about relationships.

edeast: I'm not an expert on modern explicit models of monetary exchange. But from what I understand, a common and easy way to explain why people use money is to assume decentralised markets plus anonymity. Anonymity means you can't use some sort of credit system where you get the goods now and promise to provide goods in return at some future date or some other location. They don't know who you are, so can't check whether you keep your promise.

spencer: I agree that employment looks a lot like that, with long term contracts, either explicit or implicit. That was what Barro's 1977 paper was about. But the output market usually doesn't look like that. And even in the labour market, firms typically reserve the right to layoff workers in the event of a decline in demand for their product. The question is whether as many workers are laid off than they would be if wages were flexible. (That's distinct from the question of whether employment on average over the business cycle would be higher if wages were more flexible.

Luis: I disagree. The fact that some prices are more flexible than others causes changes in relative prices and the composition of output and excess supplies. But even if all prices were equally rigid, in the face of an exogenous increased demand or decreased supply of money would still cause excess supplies of all goods, and a recession.

Scott: That's about right. The Caplin Spulber(?) model, IIRC, had an s,S pricing rule. When your price gets 1-s% below the equilibrium adjust it to S-1% above the equilibrium. This was in a model where the equilibrium price was always rising over time, but at faster or slower rates. And where s and S were independent of the expected equilibrium path, or how much time had elapsed. Carleton's cafeteria changes prices once per year. That's more like the Taylor model than Calvo.

I really dislike the Calvo assumption of purely random times at which to change price. We know it's wrong, and it rules out inflation inertia (which seems to exist). But we do it because it's mathematically tractable, since all firms have the same chance of changing prices each period, so we can use representative firm analysis.

Funnily enough "history", in the form of the 1982 recession, was influential in my thinking too. I wonder why that is? Is it because we get a richer reading of events by living through them, or by studying them as a historian, than by looking at aggregate data on P and Y etc.? And this helps us identify shocks to money demand and supply better? (Like Friedman and Schwartz's Monetary History of the US?).

Jon: supermarkets can face downward-sloping demand curves, and still have zero margins of P over *ATC* in equilibrium. Are you sure those "razor thin margins" are margins of P over MC, or over ATC? I can't believe that individual supermarkets face horizontal demand curves. The cost of travelling to the next nearest supermarket is not trivial. Plus, they are all different in other ways, so not every customer will switch 100% for a 5% increase in relative price.

Nick: I tend to agree with David that the big Macro events aren't explicable on the basis of price stickiness. This is recognized by the SPs themselves insofar as they rely on the liquidity trap, which of course can't be fixed by flexible prices. But why is there so much resistance to the multiple real equilibria interpretation of macroeconomic experience? - whether Farmer, or Diamond's search externality model, or any number of others. The sticky price stuff can explain what goes on this side of Leijohufvud's corridor. On the other side I think you need the idea of multiple Pareto-ranked real equilibria.

kevin: I think there are two questions:

1. Is current Y determined by the AD curve plus sticky prices? In other words, are we off the LRAS curve in the short run. All sticky-price (or sticky wage) macroeconomists must answer "Yes" to this question, by definition.

2. Is the AD curve downward-sloping, or vertical? In other words, would increased price flexibility get us back to the LRAS curve? If you believe in liquidity traps, for example, you believe the AD is vertical (at least under some circumstances), and so if prices were perfectly flexible we would now face explosive deflation, but that would not get us back to the LRAS curve. A sticky-price macroeconomist could answer yes or no to this question.

I think that sticky-price macroeconomists, plus their critics, tend to conflate these two questions. I say "yes" to 1, and sometimes refuse to answer 2, on the grounds that it's a hypothetical! Since prices *are* sticky, we need to work with that, and what would happen if they were perfectly flexible (whether we would return immediately to full employment, or just have explosive deflation) is not a relevant policy question.

Kevin: continued: and the multiple equilibria people are either saying:

3. There's not one LRAS curve, but several, so that if AD falls by a big enough amount, we might get onto a lower LRAS curve, with lower Y, and yet zero downward pressure on prices, and actually upward pressure on prices if we shift AD right a little bit.

4. There's not one AD curve, but several. If a big temporary shock shifts it left, we can't easily shift it right again. There's hysterisis in AD. But if AD falls, there will be permanent deflationary pressure (unlike 3 above).

Nick: to take the most extreme example the typical markup over wholesale at walmart is one cent. Those are tight margins, and this has been transformational in that segment of the retail market.

The situation among low-cost grocers just isn't comparable to an upmarket retailer like H&M or niche chains such as Whole Foods.

Look at the price history of this property in the Seattle area. Sticky prices? Perhaps. The mechanism in this case is a slow-step reverse auction combined with seller patience / stubbornness / optimism / perception that product is semi-unique or specially valuable?

http://www.redfin.com/WA/Seattle/7500-S-Taft-St-98178/home/177690

Jon: I just find it hard to imagine how Walmart can cover its costs of labour, inventory-keeping, etc., at that sort of margin. Even if they do pay low wages and have very high volume and excellent inventory control. But even if Walmart is perfectly competitive, their suppliers might not be, and retailers on average might not be. (And does Walmart not have a lot of prices at $4.99 etc., which is hard for me to reconcile with PC and price flexibility).

Indy: Good example. Apparent price stickiness in the housing market has always interested me. There are no long term implicit contracts there between sellers and potential buyers. Both the "jumpiness" of listed prices (which may not necessarily mean jumpiness of actual transactions prices). Plus the fact that we always seem to have large inventories when prices are falling, and small inventories when prices are rising. That certainly makes it look like slow adjustment of prices towards equilibrium prices, with variations in excess supply or demand being the result. Typically, it's harder to buy and easier to sell in a rising market, and the converse in a falling market. If prices adjusted instantly to changes in demand or supply, even if houses and buyers are heterogeneous (so it's a search and matching market), we wouldn't have the concepts of "buyers' market" and "sellers' market", and they wouldn't correlate with falling and rising prices.

The housing market always makes me think that there might be something to Lucas 1972 after all. Nobody is forcing sellers and buyers to have sticky prices. It's just that their expectations of market equilibrium do seem to take a long time to adjust.

Nick: a fair point about wholesale costs, but a fairer point to me would be that unit costs at walmart are frequently fractions of a dollar, so that could still be tens of a percent.

And its true that walmart pays below the general wholesale because they are very good at browbeating suppliers and finding lower-cost suppliers.

Still, you have to make a contrast with other retailers. For instance, Whole Foods had been earning bottom-line profits around twenty-percent of revenue which suggest phenomenal margins.

I don't shop at walmart, so I don't know if they offer a lot of goods at 4.99, do they? What wouldn't surprise me is that they still practice price (search) discrimination techniques. Some goods being priced close to cost (or below), and others priced too high to advantage the one-stop shop format that they have.

They used to have a compaign where they explicitly advertised that they didn't have 99c prices.

Okay, so net income is about 3.5% of revenue and operating income is about 6% of revenue. That doesn't really tell you how far apart marginal revenue and marginal cost are though.

I'm reading a paper that might fit into mankiw's information stickyness. It uses rational inattention to explain why prices are flexible to "idiosyncratic" shocks but slow to nominal.

Rather it's against Mankiw, is 125 cititations good in economics? I am partial to information theory, but I'm not sure how well received Christopher Sims work is, in econ.

Here is asecond paper based on Sims work. It covers discrete price changes, which you mention in your next post.

Nick:

I have been out of town until now. Just read your reply to my post; very well done. (It's a pleasure to read such thoughtful and learned responses of this sort -- the general discussion has been great too).

Your point on anonymity and money was a good one. True, the demand for money (in the modern monetary literature) is motivated by some degree of anonymity (otherwise, credit is possible). I will have to think about how one might square monetary trade (anonymity) with the relationship trade I stressed.

Let me summarize my main points. These are as follows. Nominal price "rigidities" appear to be an empirical fact. But do not confuse fact with theory; there are potentially many different ways to interpret price stickiness. This is potentially important because different interpretations can lead to very different policy conclusions. To simply assume that prices are sticky and then arrive at a very strong policy conclusion (a la Paul Krugman) seems wrong to me (and potentially dangerous).

Nick, you appear to be sympathetic to this. And you defend the sticky price hypothesis in an admirable way. I am fine with this. I would only add that policy conclusions based on this assumption should not be held with religious conviction (I am not accusing you of this...you know who I am talking about).

I do have one question for you. You say:

"A model of recessions that says they are caused by an excess demand for the medium of exchange seems right to me. I think I see more resort to home production, barter, and private monies during a recession, and I do see more incentive for people to do so."

What, in your view, causes an "excess demand for the medium of exchange?" Do you believe that the recent recession what caused by a sudden excess demand for US government money and treasuries? Do you have something deeper than that in mind?

Thanks David! I only just saw your comment. Nearly missed it altogether.

"What, in your view, causes an "excess demand for the medium of exchange?" Do you believe that the recent recession what caused by a sudden excess demand for US government money and treasuries? Do you have something deeper than that in mind?"

Good question. I wish I had a better answer. If I did have a better answer, my theory would be a lot more testable. This is all I've got:

Lots of things might. (Good cop out answer!)

Sometimes, like in the 1982 recession, a negative shock to money supply looks like the reason. The Bank of Canada wanted to reduce inflation, and finally tightened monetary policy enough to do so. Trouble is, even here we can't expect to be able to clearly identify a supply shock from a demand shock, since lower expected inflation would increase the demand for money.

Sometimes, it's a fall in the natural rate of interest. (1991 recession?)

Sometimes, like in the recent recession, it's caused by a rush to liquidity, when some previously liquid assets become a lot less liquid, and people and FIs might have to unwind positions very quickly. The medium of exchange is the most liquid of all assets. The US dollar, as the world's reserve currency, is money to all the other monies. If you want to exchange Loonies for Aussie dollars, you have to go through the US dollar. Just as if you want to exchange apples for bananas, you have to go through money.

That's not really *much* deeper than "a sudden excess demand for US government money and treasuries", but it's a little bit deeper.

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