Econometrica

Journal Of The Econometric Society

An International Society for the Advancement of Economic
Theory in its Relation to Statistics and Mathematics

Edited by: Guido W. Imbens • Print ISSN: 0012-9682 • Online ISSN: 1468-0262

Econometrica: Sep, 2020, Volume 88, Issue 5

Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty

https://doi.org/10.3982/ECTA14234
p. 1899-1938

Cosmin Ilut, Rosen Valchev, Nicolas Vincent

We propose a new theory of price rigidity based on firms' Knightian uncertainty about their competitive environment. This uncertainty has two key implications. First, firms learn about the shape of their demand function from past observations of quantities sold. This learning gives rise to kinks in the expected profit function at previously observed prices, making those prices both sticky and more likely to reoccur. Second, uncertainty about the relationship between aggregate and industry‐level inflation generates nominal rigidity. We prove the main insights analytically and quantify the effects of our mechanism. Our estimated quantitative model is consistent with a wide range of micro‐level pricing facts that are typically challenging to match jointly. It also implies significantly more persistent monetary non‐neutrality than in standard models, allowing it to generate large real effects from nominal shocks.


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Supplement to "Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty"

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Supplement to "Paralyzed by Fear: Rigid and Discrete Pricing under Demand Uncertainty"

This appendix contains material not found within the manuscript.

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