Sticky Prices

Sticky prices (also called nominal rigidities) describe situations where firms do not instantaneously change the prices they charge even when underlying economic conditions shift. This stickiness is a foundational assumption of New Keynesian macroeconomics and helps explain why monetary policy has real effects on output and employment in the short run, rather than only influencing the price level as classical models would predict.

Several mechanisms are commonly cited as sources of price stickiness:

• Menu costs: the literal and figurative costs of changing posted prices, a concept formalized by economists including N. Gregory Mankiw and George Akerlof in the 1980s.
• Staggered contracts: wage and price agreements that lock in nominal terms for fixed periods, modeled in the Taylor (1980) and Calvo (1983) pricing frameworks.
• Information frictions and rational inattention, associated with work by Christopher Sims.
• Coordination failures: firms reluctant to move prices before competitors do.
• Customer relationships and implicit contracts, where frequent price changes are seen as unfair or damaging to goodwill.

Empirical studies, including work by Mark Bils and Peter Klenow using U.S. CPI microdata, find that the median consumer good price changes roughly every 4–7 months, though there is wide variation across categories (gasoline adjusts frequently; haircuts rarely).

For policy analysts, sticky prices matter because they justify activist central-bank responses to demand shocks: if prices were perfectly flexible, monetary expansion would simply raise inflation. With stickiness, lower interest rates can temporarily boost real output. The concept also underpins models used at institutions like the IMF, the Federal Reserve, and the ECB, and is central to debates over inflation targeting, the Phillips curve, and the costs of disinflation.

Sticky prices are typically contrasted with flexible prices (assumed in Real Business Cycle models) and complemented by the related concept of sticky wages.