Pervasive Stickiness

This paper explores a macroeconomic model of the business cycle in which stickiness of information is a pervasive feature of the environment. Prices, wages, and consumption are all assumed to be set, to some degree, based on outdated information sets. We show that a model with such pervasive stickiness is better at matching some key facts that describe economic fluctuations than is either a benchmark classical model without such informational frictions or a model with only a subset of these frictions. The benchmark classical model that provides the starting point for this exercise will seem familiar to most readers. Prices are based on marginal cost; wages are based on the marginal rate of substitution between work and leisure; the demand for output is derived from a forward-looking consumption Euler equation; and interest rates are set by the central bank according to a conventional Taylor rule. The economy is buffeted by two kinds of disturbances: shocks to the production function and shocks to monetary policy. To this benchmark model, we add the assumption of sticky information. In Mankiw and Reis (2002) and Reis (forthcoming) we showed that if firms are assumed to set prices based on outdated information sets, certain features of inflation dynamics are more easily explained. In Mankiw and Reis (2003) we found that sticky information on the part of workers could account for some features of the labor market. And Reis (2004) discovered that inattentiveness on the part of consumers helps explain the dynamics of consumption.1 Here we show that pervasive stickiness of this type can simultaneously help explain several features of business-cycle dynamics.