Are Prices Too Sticky?
NBER Working Paper No. 2171 (Also Reprint No. r1301)
This paper shows that small costs of changing nominal prices can lead to rigidities that cause highly inefficient fluctuations in real variables. As a result, aggregate demand stabilization can be very desirable even though the frictions that cause fluctuations in aggregate demand to have real effects are slight. Inefficient price rigidity arises because rigidity has a negative externality: rigidity in one firm's price increases the variability of real aggregate demand, which hurts all firms. The externality can be arbitrarily large relative to the private costs of rigidity.
Published: The Quarterly Journal of Economics, Vol. 104, Issue 3, pp. 507-524,(August 1989).