Are Sticky Prices Costly? Evidence from the Stock Market

Abstract

We show that after monetary policy announcements, the conditional volatility of stock market returns rises more for firms with stickier prices than for firms with more flexible prices. This differential reaction is economically large as well as strikingly robust to a broad array of checks. These results suggest that menu costs-broadly defined to include physical costs of price adjustment, informational frictions, and so on-are an important factor for nominal price rigidity at the micro level. We also show that our empirical results are qualitatively and, under plausible calibrations, quantitatively consistent with New Keynesian macroeconomic models in which firms have heterogeneous price stickiness. Because our framework is valid for a wide variety of theoretical models and frictions preventing firms from price adjustment, we provide "model-free" evidence that sticky prices are indeed costly for firms. JEL classification: E12, E31, E44, G12, G14Keywords: menu costs, sticky prices, asset prices, high frequency identification * This research was conducted with restricted access to the Bureau of Labor Statistics (BLS) data. The views expressed here are those of the authors and do not necessarily reflect the views of the BLS. We thank our project coordinator at the BLS, Ryan Ogden, for help with the data, and Emi Nakamura and Jón Steinsson for making their data available to us. We thank Francesco D'Acunto, Jon Faust, Luca Fornaro (discussant), Simon Gilchrist, Robert Hall, Nir Jaimovich, Hanno Lustig, Martin Lettau, Guido Menzio, Rick Mishkin, Adair Morse, Emi Nakamura, Francisco Palomino (discussant), Ricardo Reis (discussant), Raphael Schoenle, Eric Sims, Jón Steinsson, Joe Vavra, Mike Woodford, anonymous referees, participants in the 2013 Barcelona Summer Forum, the 4 th Boston University/ Boston Fed Conference on Macro-Finance Linkages, Chicago, Columbia, the ECB -Bundesbank -House of Finance seminar, the 2013 ESNAS meeting, the 10 th German Economists abroad conference, Harvard, HEC Montreal, LSE, Munich, the NBER EFG Fall meeting 2013, the 2013 NBER SI EFG Price Dynamics working group, University of Pennsylvania, Philadelphia Fed, Santa Cruz, and especially Olivier Coibion and David Romer for valuable comments. We gratefully acknowledge financial support from the Coleman Fung Risk Management Research Center at UC Berkeley. Gorodnichenko also thanks the NSF and the Sloan Research Fellowship for financial support. Weber also thanks the University of Chicago and the Neubauer Family Foundation for financial support.† Department of Economics, University of California at Berkeley, Berkeley, USA. email: ygorodni@econ.berkeley.edu ‡ Booth School of Business, University of Chicago, Chicago, USA. email: michael.weber@chicagobooth.edu. I IntroductionIn principle, fixed costs of changing prices can be observed and measured. In practice, such costs take disparate forms in different firms, and we have no data on their magnitude.So the theory can be tested at best indirectly, at worst not at all. Alan Blinder (1991) ...