Adam Smith Business School

Dr Tom Holden, Bundesbank

"Rationing Under Sticky Prices"
Thursday, 10 October 2024. 15:00-16:30
Room 133, Hetherington Building

Abstract

Consumer demand places an upper bound on sales, not a lower bound. And yet, when we solve sticky price models (Calvo or menu-cost), we assume firms sell the entire quantity demanded at their price. This produces completely unreasonable behaviour, as firms with old prices end up selling at a price below their marginal cost. Instead, firms should ration demand to keep their marginal costs no greater than their price. We show in a continuous time New Keynesian (NK) model with idiosyncratic demand shocks that this produces drastically different results to the standard NK model. Whereas a standard sticky price model can never generate the jump in the price level we see following cleanly identified monetary shocks, the model with rationing can. Whereas a standard sticky price cannot match the flattening of the Phillips curve when output & inflation are low, the model with rationing does, and when output & inflation are high, the Phillips curve can become so steep it bends backwards. Whereas in standard sticky price models, the optimal inflation rate is always very close to zero, in models with rationing the optimal inflation rate can be really quite high. The model with rationing also fixes many of the counter-intuitive properties of the standard NK model, such as the upper bound on inflation.

Bio

Tom is a researcher in the Deutsche Bundesbank's Research Centre. Previously, he was an Assistant Professor at the University of Surrey. His PhD is from the University of Oxford. Tom works on topics in macroeconomics and monetary economics. He has recently published in Econometrica (on monetary rules) and in the Review of Economics and Statistics (on occasionally binding constraints).

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First published: 19 September 2024