Price plans and the real effects of monetary policy ∗

Transitory price changes, namely short lived deviations from a reference price level, are prominent in the data but do not fit neatly in standard sticky price models. We analyze a sticky price model where a firm chooses a price plan, namely a set of 2 prices. Changing the plan entails a menu cost, but either price in the plan can be charged at any point in time. The setup generates a persistent reference price level and short lived deviations from it. Moreover, it generates a decreasing hazard function for price changes, consistent with some datasets. We analytically solve for the optimal policy and for the cumulative output response caused by a monetary shock. We show that the temporary price changes substantially increase the flexibility of the aggregate price level. JEL Classification Numbers: E3, E5