Sticky Prices as Coordination Failure
NBER Working Paper No. 2327
This paper shows that nominal price rigidity can arise from a failure to coordinate price changes. If a firm's desired price is increasing in others' prices, then the gains to the firm from adjusting its price after a nominal shock are greater if others adjust. This "strategic complementarity" in price adjustment can lead to multiple equilibria in the degree of nominal rigidity. Welfare may be much higher in the equilibria with less rigidity. In addition, with multiple equilibrium degrees of rigidity, the economy may have several short-run equilibria but a unique long-run equilibrium.
Published: American Economic Review, Vol. 81, No. 3, pp. 539-552, June 1991.