In Search of Real Rigidities

Abstract

The closed and open economy literatures work on estimating real rigidities, but in parallel. We bring the two literatures together to shed light on this question. We use international price data and exchange rate shocks to evaluate the importance of real rigidities in price setting. We show that consistent with the presence of real rigidities the response of reset-price inflation to exchange rate shocks depicts significant persistence. Individual import prices, conditional on changing, respond to exchange rate shocks prior to the last price change. At the same time aggregate reset-price inflation for imports, like that for consumer prices, depicts little persistence. Competitors prices effect firm pricing and exchange rate pass-through into import prices are greater in response to trade-weighted as opposed to bilateral exchange rate changes. We quantitatively evaluate sticky price models (Calvo and menu cost) with variable markups at the wholesale level and constant markups at the retail level, consistent with empirical evidence. Variable markups alone generate sluggishness in price adjustment and increase the size of the contract multiplier, but their effects are modest.