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Behavioral Sticky Prices

Author

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  • Rebelo, Sérgio
  • Santana, Miguel
  • Teles, Pedro

Abstract

We study a model where households make decisions according to a dual process framework widely used in cognitive psychology. System 1 uses effortless heuristics but is susceptible to biases and errors. System 2 uses mental effort to make more accurate decisions. Through their pricing behavior, monopolistic producers can influence whether households deploy Systems 1 or 2. The strategic use of this influence creates a new source of price inertia and provides a natural explanation for the †rockets and feathers†phenomenon: prices rise quickly when costs increase but fall slowly when costs fall. Our model implies that price stability is not optimal.

Suggested Citation

  • Rebelo, Sérgio & Santana, Miguel & Teles, Pedro, 2024. "Behavioral Sticky Prices," CEPR Discussion Papers 18884, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18884
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    Keywords

    Sticky prices; System 1 and 2;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E71 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on the Macro Economy

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