Delivering Endogenous Inertia in Prices and Output

This paper presents a DGE model in which aggregate price level inertia is generated endogenously by the optimizing behaviour of price setting …rms. All the usual sources of inertia are absent here ie., all …rms are simultaneously free to change their price once every period and face no adjustment costs in doing so. Despite this, the model generates persistent movements in aggregate output and in‡ation in response to a nominal shock. Two modi…cations of a standard onequarter pre-set price model deliver these results: learning-by-doing and habit formation in leisure.