Non-Constant Demand Elasticities, Firm Dynamics and Monetary Non-Neutrality: Role of Demand Shocks
We revisit the role of micro real rigidities as a driver of monetary non-neutrality, using a simple menu-cost model featuring non-constant elasticity of demand with both idiosyncratic productivity and demand shocks. The model is calibrated to match firm-level productivity and demand processes estimated from U.S. data. Despite its simplicity, the calibrated model overturns prior negative findings in the literature on micro real rigidities and generates sizeable monetary non-neutrality comparable to alternative frameworks. Additionally, the model reproduces untargeted pricing dynamics and a markup distribution consistent with U.S. microdata. As a result, this framework effortlessly unifies pricing, markup behavior, and firm dynamics. The key to reconciling firm-level and pricing dynamics lies in the interaction between non-constant demand elasticity and idiosyncratic demand shocks.
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