Price plans and the real effects of monetary policy

Abstract

We analyze a sticky price model where a firm chooses a price plan, namely a set of 2 prices. Changing the plan entails a menu cost, but either price in the plan can be charged at any point in time. The setup generates a persistent reference price level and short lived deviations from it, and a decreasing hazard function for price changes, consistent with some datasets. We analytically solve for the optimal policy and for the cumulative output response caused by a monetary shock. We show that the temporary price changes substantially increase the flexibility of the aggregate price level.