Phillips curves with observation and menu costs ∗

We compute the response of output to a monetary shock in a general equilibrium model in which firms set prices subject to a menu cost as well a costly observation of the state. We consider economies that are observationally equivalent with respect to the average frequency and size of price adjustments, and show that these economies respond differently to monetary shocks, depending on the size of the menu cost relative to the observation cost. A calibration on US data requires both costs to be present and predicts real effects that are more persistent than in the corresponding menu-cost model, but smaller than in the observation-cost model. The presence of the observation cost injects a time dependent component in the firms’ decision rule which makes the impulse response quasi linear in the size of the shock. JEL Classification Numbers: E5