Paper #773

Title:

Pitfalls in the modeling of forward-looking price setting and investment decisions

Authors:

Tommy Sveen and Lutz Weinke

Date:

September 2004

Abstract:

The present paper makes progress in explaining the role of capital for inflation and output dynamics. We followWoodford (2003, Ch. 5) in assuming Calvo pricing combined with a convex capital adjustment cost at the firm level. Our main result is that capital accumulation affects inflation dynamics primarily through its impact on the marginal cost. This mechanism is much simpler than the one implied by the analysis in Woodford's text. The reason is that his analysis suffers from a conceptual mistake, as we show. The latter obscures the economic mechanism through which capital affects inflation and output dynamics in the Calvo model, as discussed in Woodford (2004).

Keywords:

Sticky prices, investments

JEL codes:

E22, E31

Area of Research:

Macroeconomics and International Economics

Published in:

Journal of Monetary Economics
With the title:
Lumpy Investment, Sticky Prices, and the Monetary Transmission Mechanism

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