The roles of price points and menu costs in price rigidity

Posted by D. Daniel Sokol

Edward S. Knotek II (Federal Reserve Bank of Kansas City) explains The roles of price points and menu costs in price rigidity.

ABSTRACT: Macroeconomic models often generate nominal price rigidity via menu costs. This paper provides empirical evidence that treating menu costs as a structural explanation for sticky prices may be spurious. Using supermarket scanner data, I note two empirical facts: (1) price points, embodied in nine-ending prices, account for more than 60 percent of prices; (2) at the conclusion of sales, post-sale prices return to their pre-sale levels nearly 90 percent of the time. I construct a model that nests roles for menu costs and price points and estimate model variants via simulated method of moments. Excluding the two facts yields a statistically and economically significant role for menu costs in generating price rigidity. Incorporating the two facts yields an incentive to set nine-ending prices two orders of magnitude larger than the menu costs in this model. In this setting, the price point model can match the two stylized fact! s, but menu costs are effectively irrelevant as a source of price rigidity. The choice of a mechanism for price rigidity matters for aggregate dynamics.