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BPEA Article

Aggregate and Individual Price Adjustment

Abstract

CENTRAL to the Keynesian interpretation of economic fluctuations is the notion that prices and wages are rigid or "sticky," so that movements in aggregate demand, rather than being quickly reflected in price level movements, have instead long-lasting effects on output and economic activity. The word "rigidity" covers, in fact, two quite different notions. The first, which I shall refer to as real rigidity, is that real wages and markups of prices over wages respond little to shifts in demand. The second, which I shall refer to as nominal rigidity, is that nominal wages and prices respond slowly to changes in their determinants and in particular responds lowly to each other. Both real and nominal rigidities combine to lead to lasting effects of changes in aggregate demand on output. The focus of the paper is on nominal rigidities. In earlier work on the joint behavior of prices, wages, and employment, I found that, contrary to prevailing wisdom, there appeared to be as much nominal price rigidity as nominal wage rigidity. This paper explores those findings further, looks at how interactions between individual prices lead to aggregate nominal price rigidity, and points out the macroeconomic implications of nominal price rigidity.

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