DP4858 | Firm-Specific Capital, Nominal Rigidities and the Business Cycle

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Macroeconomic and microeconomic data paint conflicting pictures of price behaviour. Macroeconomic data suggest that inflation is inertial. Microeconomic data indicate that firms change prices frequently. We formulate and estimate a model that resolves this apparent micro/macro conflict. Our model is consistent with post-war US evidence on inflation inertia even though firms re-optimize prices on average once every 1.5 quarters. The key feature of our model is that capital is firm-specific and pre-determined within a period.