Predetermined Prices and the Persistent Effects of Money on Output

Abstract

This note illustrates a model of predetermined pricing, where firms set a fixed schedule of nominal prices at the time of price readjustment, based on the work of Fischer (1977). This contrasts with the model of fixed pricing, the specification underlying most recent dynamic sticky-price models. It is well known that predetermined pricing cannot generate substantial persistence in the real effects of monetary shocks when prices are set via fixed duration contracts unless the contracts are of long duration. However, we show that with a probabilistic model of price adjustment, a predetermined pricing specification can produce almost as much persistence as the more conventional model of fixed prices, without the assumption of long average contract duration.