Editing Nominal rigidity (section)

==Sticky information==

In macroeconomics, sticky information is old information used by agents as a basis for their behavior—information that does not take into account recent events. The first model of sticky information was developed by [[Stanley Fischer]] in his 1977 article.<ref>{{cite journal |last=Fischer |first=S. |year=1977 |title=Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule |journal=[[Journal of Political Economy]] |volume=85 |issue=1 |pages=191–205 |jstor=1828335 |doi=10.1086/260551|url=http://dspace.mit.edu/bitstream/1721.1/63894/1/longtermcontract00fisc.pdf |hdl=1721.1/63894 |s2cid=36811334 |hdl-access=free }}</ref>  He adopted a "staggered" or "overlapping" contract model. Suppose that there are two unions in the economy, who take turns to choose wages. When it is a union's turn, it chooses the wages it will set for the next two periods. In contrast to [[John B. Taylor]]'s model where the nominal wage is constant over the contract life, in Fischer's model the union can choose a different wage for each period over the contract. The key point is that at any time t, the union setting its new contract will be using the up-to-date latest information to choose its wages for the next two periods. However, the other union is still setting its wage based on the contract it planned last period, which is based on the old information.

The importance of sticky information in Fischer's model is that whilst wages in some sectors of the economy are reacting to the latest information, those in other sectors are not. This has important implications for monetary policy. A sudden change in monetary policy can have real effects, because of the sector where wages have not had a chance to adjust to the new information.

The idea of sticky information was later developed by [[N. Gregory Mankiw]] and [[Ricardo Reis]].<ref>{{cite journal |last1=Mankiw |first1=N. G. |first2=R. |last2=Reis |year=2002 |title=Sticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips Curve |journal=[[Quarterly Journal of Economics]] |volume=117 |issue=4 |pages=1295–1328 |doi=10.1162/003355302320935034 |s2cid=1146949 |url=http://nrs.harvard.edu/urn-3:HUL.InstRepos:3415324 }}</ref> This added a new feature to Fischer's model: there is a fixed probability that one can replan one's wages or prices each period. Using quarterly data, they assumed a value of 25%: that is, each quarter 25% of randomly chosen firms/unions can plan a trajectory of current and future prices based on current information. Thus if we consider the current period, 25% of prices will be based on the latest information available, and the rest on information that was available when they last were able to replan their price trajectory. Mankiw and Reis found that the model of sticky information provided a good way of explaining inflation persistence.

===Evaluation of sticky information models===

Sticky information models do not have nominal rigidity: firms or unions are free to choose different prices or wages for each period. It is the information that is sticky, not the prices. Thus when a firm gets lucky and can re-plan its current and future prices, it will choose a trajectory of what it believes will be the optimal prices now and in the future. In general, this will involve setting a different price every period covered by the plan.

This is at odds with the empirical evidence on prices.<ref>{{cite journal |first1=V. V. |last1=Chari |first2=Patrick J. |last2=Kehoe |first3=Ellen R. |last3=McGrattan |year=2008 |url=http://www.minneapolisfed.org/research/sr/sr409.pdf |title=New Keynesian Models: Not Yet Useful for Policy Analysis |journal=Federal Reserve Bank of Minneapolis Research Department Staff Report 409 }}</ref><ref name="Knotec2010">{{cite journal |first=Edward S. II |last=Knotec |year=2010 |title=A Tale of Two Rigidities: Sticky Prices in a Sticky-Information Environment |journal=Journal of Money, Credit and Banking |volume=42 |issue=8 |pages=1543–1564 |doi=10.1111/j.1538-4616.2010.00353.x }}</ref> There are now many studies of price rigidity in different countries: the US,<ref name="KlenowKryvtsov2008" /> the Eurozone,<ref name="Dhyne">{{cite journal |first1=Luis J. |last1=Álvarez |first2=Emmanuel |last2=Dhyne |first3=Marco |last3=Hoeberichts |first4=Claudia |last4=Kwapil |first5=Hervé |last5=Le Bihan |first6=Patrick |last6=Lünnemann |first7=Fernando |last7=Martins |first8=Roberto |last8=Sabbatini |first9=Harald |last9=Stahl |first10=Philip |last10=Vermeulen |first11=Jouko |last11=Vilmunen |year=2006 |title=Sticky Prices in the Euro Area: A Summary of New Micro-Evidence |journal=[[Journal of the European Economic Association]] |volume=4 |issue=2–3 |pages=575–584 |doi=10.1162/jeea.2006.4.2-3.575 |hdl=10419/152997 |s2cid=56011601 |url=http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp563.pdf }}</ref> the UK<ref name=Bunn>{{cite journal |first1=Philip |last1=Bunn |first2=Colin |last2=Ellis |year=2012 |title=Examining The Behaviour Of Individual UK Consumer Prices |journal=[[The Economic Journal]] |volume=122 |issue=558 |pages=F35–F55 |doi=10.1111/j.1468-0297.2011.02490.x |s2cid=153322174 }}</ref> and others. These studies all show that whilst there are some sectors where prices change frequently, there are also other sectors where prices remain fixed over time. The lack of sticky prices in the sticky information model is inconsistent with the behavior of prices in most of the economy. This has led to attempts to formulate a "dual stickiness" model that combines sticky information with sticky prices.<ref name="Knotec2010" /><ref>{{cite journal |first1=Bill |last1=Dupor |first2=Tomiyuki |last2=Kitamura |first3=Takayuki |last3=Tsuruga |title=Integrating Sticky Prices and Sticky Information |journal=[[Review of Economics and Statistics]] |year=2010 |volume=92 |issue=3 |pages=657–669 |doi=10.1162/REST_a_00017 |citeseerx=10.1.1.595.2382 |s2cid=57569783 }}</ref>

===Sticky inflation assumption===

The sticky inflation assumption states that "when firms set prices, for various reasons the prices respond slowly to changes in monetary policy. This leads the rate of inflation to adjust gradually over time."<ref>Charles I. Jones, Macroeconomics, 3rd edition. Text (Norton, 2013) p.309.</ref>
Additionally, within the context of the short run model there is an implication that the classical dichotomy does not hold when sticky inflation is present. This is the case when monetary policy affects real variables. Sticky inflation can be caused by expected inflation (e.g. home prices prior to the recession), wage push inflation (a negotiated raise in wages), and temporary inflation caused by taxes. Sticky inflation becomes a problem when economic output decreases while inflation increases, which is also known as [[stagflation]]. As economic output decreases and [[unemployment]] rises the standard of living falls faster when sticky inflation is present. Not only will inflation not respond to monetary policy in the short run, but monetary expansion as well as contraction can both have negative effects on the standard of living.